SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒ Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 20212022
OR
☐ Transition Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 001-38661
elan-20220331_g1.jpg
Elanco Animal Health Incorporated
(Exact name of Registrant as specified in its charter)
INDIANA 82-5497352
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address of principal executive offices)
Registrant’s telephone number, including area code (877) 352-6261
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common stock, no par valueELANNew York Stock Exchange
5.00% Tangible Equity UnitsELATNew York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer☒Accelerated filer☐
Non-accelerated filer☐Smaller reporting company☐
Emerging growth company☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
The number of shares of common stock outstanding as of May 3, 2021 were 472,995,963
4, 2022 was 474,096,131.




ELANCO ANIMAL HEALTH INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 20212022
TABLE OF CONTENTS
Item 1.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
5
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVELOSS INCOME (LOSS) (UNAUDITED)
6
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
7
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
8
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
9
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
10
Item 2.
OVERVIEW
2826
RESULTS OF OPERATIONS
3231
SUMMARY OF CHANGES
3332
LIQUIDITY AND CAPITAL RESOURCES
3634
Item 3.
3736
Item 4.
3837
Item 1.
3937
Item 1A.
3937
Item 2.
4037
Item 3.
4037
Item 4.
4038
Item 5.
4038
Item 6.
4139
4240

20212022 Q1 Form 10-Q | 2
elan-20220331_g1.jpg

Table of Contents
FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY

This Quarterly Report on Form 10-Q (Form 10-Q) includes forward-looking statements within the meaning of the federal securities laws. This quarterly report containsThese forward-looking statements, including,include, without limitation, statements concerning the impact on Elanco Animal Health Incorporated and its subsidiaries (collectively, Elanco, the Company, we, us or our) caused by the integration of Kindred Biosciences, Inc. (KindredBio) and the animal health business of Bayer Aktiengesellschaft (Bayer), expected synergies and our cost savings, product launches, independent company stand-up costs and timing, expectations relating to human capital resources, the coronavirus (COVID-19) global pandemic, conflict involving Russia and Ukraine and the potential impact on our business and global economic conditions, reduction of debt, expectations relating to liquidity and sources of capital, our expected compliance with debt covenants, cost savings, expenses, and reserves relating to restructuring actions, our industry and our operations, performance and financial condition, and including, in particular, statements relating to our business, growth strategies, distribution strategies, product development efforts and future expenses.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important risk factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions, including but not limited to the following:
•heightened competition, including from generics;
•the impact of disruptive innovations and advances in veterinary medical practices, animal health technologies and alternatives to animal-derived protein;
•changes in regulatory restrictions on the use of antibiotics in farm animals;
•our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;
•consolidation of our customers and distributors;
•an outbreak of infectious disease carried by farm animals;
•the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the COVID-19 global health pandemic;
•the success of our research and development (R&D)R&D and licensing efforts;
•misuse, off-label or counterfeiting use of our products;
•unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
•fluctuations in our business results due to seasonality and other factors;
•the impact of weather conditions and the availability of natural resources;
•risks related to the modification of foreign trade policy;
•risks related to currency rate fluctuations;
•our dependence on the success of our top products;
•the impact of customer exposure to rising costs and reduced customer income;
•the lack of availability or significant increases in the cost of raw materials;
•use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
•risks related to the write-down of goodwill or identifiable intangible assets;
•risks related to the evaluation of animals;
•manufacturing problems and capacity imbalances;
•the impact of litigation, regulatory investigations, and other legal matters and the risk that our insurance policies may be insufficient to protect us from the impact of such matters;
2022 Q1 Form 10-Q | 3
elan-20220331_g1.jpg
Table of Contents
•actions by regulatory bodies, including as a result of their interpretation of studies on product safety;
•risks related to tax expense or exposure;
•risks related to environmental, health and safety laws and regulations;
•risks related to our presence in foreign markets;
•challenges to our intellectual property rights or our alleged violation of rights of others;
•risks related to our presence in foreign markets;
•dependence on sophisticated information technology and infrastructure and the impact of breaches of our information technology systems;
•the impact of increased regulation or decreased financial support related to farm animals;
•adverse effects of labor disputes, strikes, work stoppages, and the loss of key personnel or highly skilled employees;
•risks related to underfunded pension plan liabilities;
•our ability to complete acquisitions and successfully integrate the businesses we acquire, including KindredBio and the animal health business of Bayer (Bayer Animal Health);
•the effect of our substantial indebtedness on our business;business, including restrictions in our debt agreements that will limit our operating flexibility; and
•the effect onrisks related to certain governance provisions in our business resulting from our separation from Eli Lilly and Company (Lilly).constituent documents.
2021 Q1 Form 10-Q | 3
elan-20210331_g1.jpg

See Item 1A, “Risk Factors,” of Part I of our Annual Report on Form 10-K (Form 10-K) for the year ended December 31, 20202021 filed with the United States (U.S.) Securities and Exchange Commission (SEC), and Part II of this Quarterly Report on Form 10-Q, for a further description of these and other factors. Although we have attempted to identify important risk factors, there may be other risk factors not presently known to us or that we presently believe are not material that could cause actual results and developments to differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. If any of these risks materialize, or if any of the above assumptions underlying forward-looking statements prove incorrect, actual results and developments may differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. For the reasons described above, weWe caution you against relying on any forward-looking statements, which should also be read in conjunction with the other cautionary statements that are included elsewhere in this quarterly report. Any forward-looking statement made by us in this quarterly report speaks only as of the date hereof. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update or to revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should be viewed as historical data.


20212022 Q1 Form 10-Q | 4
elan-20220331_g1.jpg

Table of Contents
PART I

ITEM 1. FINANCIAL STATEMENTS

Elanco Animal Health Incorporated
Condensed Consolidated Statements of Operations (Unaudited)
(in millions, except per-share data)
 Three Months Ended March 31,
 20212020
Revenue$1,242 $658 
Costs, expenses and other:
Cost of sales569 333 
Research and development89 67 
Marketing, selling and administrative348 182 
Amortization of intangible assets147 52 
Asset impairment, restructuring and other special charges108 75 
Interest expense, net of capitalized interest61 16 
Other expense, net0 1 
1,322 726 
Loss before income taxes(80)(68)
Income tax benefit(19)(19)
Net loss$(61)$(49)
Loss per share:
Basic$(0.12)$(0.12)
Diluted$(0.12)$(0.12)
Weighted average shares outstanding:
Basic486.7 403.9 
Diluted486.7 403.9 
 Three Months Ended March 31,
 20222021
Revenue$1,225 $1,242 
Costs, expenses and other:
Cost of sales509 569 
Research and development81 89 
Marketing, selling and administrative320 348 
Amortization of intangible assets137��147 
Asset impairment, restructuring and other special charges46 108 
Interest expense, net of capitalized interest52 61 
Other expense, net9 — 
1,154 1,322 
Income (loss) before income taxes71 (80)
Income tax expense (benefit)23 (19)
Net income (loss)$48 $(61)
Earnings (loss) per share:
Basic$0.10 $(0.12)
Diluted$0.10 $(0.12)
Weighted average shares outstanding:
Basic488.0 486.7 
Diluted492.2 486.7 
See notes to condensed consolidated financial statements.
20212022 Q1 Form 10-Q | 5
elan-20220331_g1.jpg

Table of Contents
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Comprehensive LossIncome (Loss) (Unaudited)
(in millions)
Three Months Ended March 31,
20212020
Net loss$(61)$(49)
Other comprehensive income (loss):
Unrealized gain (loss) on derivatives for cash flow hedges, net of taxes53 (39)
Foreign currency translation(466)(29)
Defined benefit pension and retiree health benefit plans, net of taxes8 (1)
Other comprehensive loss, net of taxes(405)(69)
Comprehensive loss$(466)$(118)
Three Months Ended March 31,
20222021
Net income (loss)$48 $(61)
Other comprehensive income (loss):
Unrealized gain on derivatives for cash flow hedges, net of taxes109 53 
Foreign currency translation(85)(466)
Defined benefit pension and retiree health benefit plans, net of taxes(1)8 
Other comprehensive income (loss), net of taxes23 (405)
Comprehensive income (loss)$71 $(466)
See notes to condensed consolidated financial statements.

20212022 Q1 Form 10-Q | 6
elan-20220331_g1.jpg

Table of Contents
Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions)
March 31, 2021December 31, 2020
(Unaudited)
Assets 
Current Assets
Cash and cash equivalents$515 $495 
Accounts receivable, net of allowances of $9 (2021) and $9 (2020)1,028 872 
Other receivables104 205 
Inventories1,424 1,578 
Prepaid expenses and other273 256 
Restricted cash0 11 
Total current assets3,344 3,417 
Noncurrent Assets
Goodwill6,016 6,225 
Other intangibles, net6,032 6,387 
Other noncurrent assets325 348 
Property and equipment, net of accumulated depreciation of $1,060 (2021) and $1,038 (2020)1,271 1,316 
Total assets$16,988 $17,693 
Liabilities and Equity
Current Liabilities
Accounts payable$411 $501 
Employee compensation114 144 
Sales rebates and discounts331 295 
Current portion of long-term debt605 555 
Other current liabilities573 582 
Total current liabilities2,034 2,077 
Noncurrent Liabilities
Long-term debt5,556 5,572 
Accrued retirement benefits316 346 
Deferred taxes828 900 
Other noncurrent liabilities247 322 
Total liabilities8,981 9,217 
Commitments and Contingencies0 0 
Equity
Preferred stock, no par value, 1,000,000,000 shares authorized; 0ne issued0 0 
Common stock, no par value, 5,000,000,000 shares authorized, 472,968,567 and 471,921,116 shares issued and outstanding as of March 31, 2021 and December 31, 2020, respectively0 0 
Additional paid-in capital8,647 8,650 
Accumulated deficit(538)(477)
Accumulated other comprehensive income (loss)(102)303 
Total equity8,007 8,476 
Total liabilities and equity$16,988 $17,693 
millions, except share data)
March 31, 2022December 31, 2021
(Unaudited)
Assets 
Current Assets
Cash and cash equivalents$342 $638 
Accounts receivable, net of allowances of $12 (2022 and 2021)973 833 
Other receivables219 195 
Inventories1,345 1,373 
Prepaid expenses and other315 237 
Total current assets3,194 3,276 
Noncurrent Assets
Goodwill6,116 6,172 
Other intangibles, net5,395 5,587 
Other noncurrent assets559 387 
Property and equipment, net of accumulated depreciation of $670 (2022) and $1,041 (2021)987 1,061 
Total assets$16,251 $16,483 
Liabilities and Equity
Current Liabilities
Accounts payable$402 $418 
Employee compensation111 185 
Sales rebates and discounts295 316 
Current portion of long-term debt61 294 
Other current liabilities438 430 
Total current liabilities1,307 1,643 
Noncurrent Liabilities
Long-term debt6,073 6,025 
Accrued retirement benefits270 271 
Deferred taxes747 745 
Other noncurrent liabilities242 261 
Total liabilities8,639 8,945 
Commitments and Contingencies00
Equity
Preferred stock, no par value, 1,000,000,000 shares authorized; none issued— — 
Common stock, no par value, 5,000,000,000 shares authorized, 474,091,024 and 473,119,786 shares issued and outstanding as of March 31, 2022 and December 31, 2021, respectively— — 
Additional paid-in capital8,699 8,696 
Accumulated deficit(901)(949)
Accumulated other comprehensive loss(186)(209)
Total equity7,612 7,538 
Total liabilities and equity$16,251 $16,483 
See notes to condensed consolidated financial statements.
20212022 Q1 Form 10-Q | 7
elan-20220331_g1.jpg

Table of Contents
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)

Common StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional Paid-in CapitalAccumulated DeficitCash Flow Hedge Gain (Loss)Foreign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2020472.0 $— $8,650 $(477)$(61)$360 $4 $303 $8,476 
Net loss— — — (61)— — — — (61)
Other comprehensive income (loss), net of tax— — — — 53 (466)8 (405)(405)
Stock compensation— — 15 — — — — — 15 
Issuance of stock under employee stock plans, net1.0 — (18)— — — — — (18)
March 31, 2021473.0 $— $8,647 $(538)$(8)$(106)$12 $(102)$8,007 
Common StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional Paid-in CapitalRetained Earnings (Accumulated Deficit)Cash Flow Hedge Gain (Loss)Foreign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2019373 $0 $5,636 $84 $— $(199)$25 $(174)$5,546 
Net loss— — — (49)— — — — (49)
Adoption of Accounting Standards Update 2016-13
— — — (1)— — — — (1)
Other comprehensive loss, net of tax— — — — (39)(29)(1)(69)(69)
Separation activities (1)
— — 16 — — — — — 16 
Stock compensation— — 11 — — — — — 11 
Issuance of stock under employee stock plans, net1 — (13)— — — — — (13)
Issuance of common stock, net of issuance costs25 — 768 — — — — — 768 
Issuance of tangible equity units, net of issuance costs— — 452 — — — — — 452 
March 31, 2020399 $0 $6,870 $34 $(39)$(228)$24 $(243)$6,661 
December 31, 2021473.1 $— $8,696 $(949)$25 $(253)$19 $(209)$7,538 
Net income— — — 48 — — — — 48 
Other comprehensive income (loss), net of tax— — — — 109 (85)(1)23 23 
Stock compensation— — 14 — — — — — 14 
Issuance of stock under employee stock plans, net1.0 — (11)— — — — — (11)
March 31, 2022474.1 $— $8,699 $(901)$134 $(338)$18 $(186)$7,612 

December 31, 2020472 $0 $8,650 $(477)$(61)$360 $4 $303 $8,476 
Net loss— — — (61)— — — — (61)
Other comprehensive income (loss), net of tax— — — — 53 (466)8 (405)(405)
Stock compensation— — 15 — — — — — 15 
Issuance of stock under employee stock plans, net1 — (18)— — — — — (18)
March 31, 2021473 $0 $8,647 $(538)$(8)$(106)$12 $(102)$8,007 

(1)Represent amounts associated with transactions between us and Lilly, related primarily to the completion of the local country asset purchases, the finalization of assets and liabilities associated with the legal separation from Lilly, centralized cash management, and resulting impacts on deferred tax assets, that occurred subsequent to our initial public offering.
See notes to condensed consolidated financial statements.
20212022 Q1 Form 10-Q | 8
elan-20220331_g1.jpg

Table of Contents
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)
Three Months Ended March 31,
 20212020
Cash Flows from Operating Activities
Net loss$(61)$(49)
Adjustments to reconcile net loss to cash flows from operating activities:
Depreciation and amortization202 82 
Change in deferred income taxes(32)(25)
Stock-based compensation expense15 11 
Asset impairment charges9 0 
Gain on sale of assets0 (4)
Inventory fair value step-up amortization62 0 
Changes in operating assets and liabilities, net of acquisitions(183)(10)
Other non-cash operating activities, net10 (1)
Net Cash Provided by Operating Activities22 4 
Cash Flows from Investing Activities
Net purchases of property and equipment(18)(13)
Cash paid for acquisitions, net of cash acquired73 0 
Proceeds from settlement of net investment hedges0 25 
Purchases of intangible assets(33)0 
Purchases of software(5)(32)
Other investing activities, net(7)0 
Net Cash Provided by (Used for) Investing Activities10 (20)
Cash Flows from Financing Activities
Repayments of borrowings(20)(371)
Net proceeds from revolving credit facility50 0 
Proceeds from issuance of long-term debt0 79 
Proceeds from issuance of common stock and tangible equity units0 1,220 
Debt issuance costs0 (3)
Other net financing transactions with Lilly(11)(15)
Other financing activities, net(17)(13)
Net Cash Provided by Financing Activities2 897 
Effect of exchange rate changes on cash and cash equivalents(25)(9)
Net increase in cash, cash equivalents and restricted cash9 872 
Cash, cash equivalents and restricted cash at January 1506 345 
Cash, cash equivalents and restricted cash at March 31$515 $1,217 

March 31,
20212020
Cash and cash equivalents$515 $1,206 
Restricted cash0 11 
Cash, cash equivalents and restricted cash at March 31$515 $1,217 
Three Months Ended March 31,
 20222021
Cash Flows from Operating Activities
Net income (loss)$48 $(61)
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation and amortization176 202 
Deferred income taxes(11)(32)
Stock-based compensation expense14 15 
Asset impairment and write-down charges28 9 
Gain on sale of assets1 — 
Inventory fair value step-up amortization— 62 
Changes in operating assets and liabilities(331)(183)
Other non-cash operating activities, net13 10 
Net Cash Provided by (Used for) Operating Activities(62)22 
Cash Flows from Investing Activities
Net purchases of property and equipment(19)(18)
Cash paid for acquisitions, net of cash acquired— 73 
Purchases of intangible assets— (33)
Purchases of software(7)(5)
Other investing activities, net(3)(7)
Net Cash Provided by (Used for) Investing Activities(29)10 
Cash Flows from Financing Activities
Proceeds from revolving credit facility63 150 
Repayments of long-term borrowings(89)(20)
Repayments of revolving credit facility(163)(100)
Other net financing transactions with Lilly— (11)
Other financing activities, net(11)(17)
Net Cash Provided by (Used for) Financing Activities(200)2 
Effect of exchange rate changes on cash and cash equivalents(5)(25)
Net increase (decrease) in cash and cash equivalents(296)9 
Cash and cash equivalents at January 1638 506 
Cash and cash equivalents at March 31$342 $515 
See notes to condensed consolidated financial statements.
20212022 Q1 Form 10-Q | 9
elan-20220331_g1.jpg

Table of Contents
Elanco Animal Health Incorporated
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share and per-unit data)

Note 1. Background

Elanco is a global animal health company that innovates, develops, manufactures and markets products for pets and farm animals. We offer a portfolio of approximately 200 brands to pet owners, veterinarians and farm animal producers in more than 90 countries. Our products are generally sold worldwide directly to wholesalers, distributors, and independent retailers. Certain products are also sold directly to farm animal producers and veterinarians. We have a diversified business of products across species consisting of: dogs and cats (collectively, pet health) and cattle, poultry, swine and aqua (collectively, farm animal).

Elanco was incorporated in Indiana on September 18, 2018, and prior to that was a business unit of Eli Lilly and Company (Lilly).

Note 1.2. Basis of Presentation and Summary of Significant Accounting Policies

Elanco was formed as a wholly-owned subsidiary of Eli Lilly and Company (Lilly). Elanco Parent was formed in May 2018 to serve as the ultimate parent company of substantially all of the animal health businesses of Lilly. In September 2018, Elanco Parent completed an initial public offering (IPO). In connection with the completion of the IPO, through a series of equity and other transactions, Lilly transferred to Elanco Parent the animal health businesses that form its business. The disposition of Elanco shares by Lilly was completed in March 2019, which resulted in the full separation of Elanco.

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the United States (U.S.)U.S. Securities and Exchange Commission (SEC) requirements for interim reporting. As permitted under those rules, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been condensed or omitted. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and combined financial statements and accompanying notes for the year ended December 31, 20202021 included in our Annual Report on Form 10-K filed with the SEC on March 1, 2021.February 28, 2022. In addition, results for interim periods should not be considered indicative of results for any other interim period or for the full year ending December 31, 2022 or any other future period.

In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for fair presentation of the results of operations for the periods shown. In preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates. Certain reclassifications of prior year information have been made to conform to the current year's presentation.

The significant accounting policies set forth in Note 43 to the consolidated and combined financial statements in our Annual Report on Form 10-K for the year ended December 31, 20202021 appropriately represent, in all material respects, the current status of our accounting policies, except as it relates to the adoption of the standard that was effective January 1, 20212022 as described in Note 2:3: Implementation of New Financial Accounting Pronouncements.

On August 1, 2020, we completed the previously announced acquisition of Bayer Animal Health. See Note 4: Acquisitions and Divestitures for additional information.

Note 2.3. Implementation of New Financial Accounting Pronouncements

The following table provides a brief description of an accounting standard that was effective January 1, 20212022 and was adopted on that date:
StandardDescriptionEffect on the financial statements or other significant matters
Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes
ASU 2021-10, Government Assistance (Topic 832)		The amendments in this update include simplifications relatedrequire annual disclosure of transactions with governments that are accounted for by applying a grant or contribution model. The new pronouncement requires entities to accounting for income taxes including removing certain exceptions related toprovide information about the approach for intraperiod tax allocationnature, terms and conditions associated with the transactions and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill.financial statement line items affected.The adoption of this guidance did not have a material impact on our consolidated financial statements.

20212022 Q1 Form 10-Q | 10
elan-20220331_g1.jpg

Table of Contents
The following table provides a brief description of an accounting standard that is applicable to us but has not yet been adopted:
StandardDescriptionEffective DateEffect on the financial statements or other significant matters
ASU 2020-04, Reference rate reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting; ASU 2021-01, Reference Rate Reform (Topic 848): Scope
ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. ASU 2021-01 clarifies the scope of Topic 848 so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions.These standards wereAdoption of the guidance is optional and effective as of March 12, 2020 through December 31, 2022 and adoption2022. Adoption is permitted at any time during the period on a prospective basis.We are currently in the process of evaluating the impact of theOur current credit facilities reference London InterbankInter-Bank Offered Rate (LIBOR) on our existing contracts and may electas a benchmark rate. The underlying credit agreements include provisions which outline criteria for establishing a consistent replacement benchmark rate in the event that LIBOR is discontinued. Therefore, it is unlikely that we will need to adopt this optional expedients in future periodsguidance. However, we will continue to evaluate the impact as reference rate reform activities occur. We do not expect that these updates will have a material impact on our consolidated financial statements.

Note 3.4. Revenue

Our sales rebates and discounts are based on specific agreements. The most significant of our sales rebate and discount programs in terms of accrual and payment amounts, percentage of our products that are sold via these programs, and level of judgment required in estimating the appropriate transaction price, relate to our programs in the U.S., France and the United Kingdom (U.K.). As of March 31, 20212022 and 2020,2021, the aggregate liability for sales rebates and discounts for these countries represented approximately 76%75% and 82%, respectively, of our total liability with the next largest country representing approximately 4% and 6%76%, respectively, of our total liability.

The following table summarizes the activity in theour global sales rebates liability in the U.S., France, and the U.K.:
Three Months Ended March 31,
20212020
Beginning balance$217 $176 
Reduction of revenue142 71 
Payments(106)(87)
Foreign currency translation adjustments(2)(1)
Ending balance$251 $159 
discounts liability:
Three Months Ended March 31,
20222021
Beginning balance$316 $295 
Reduction of revenue219 182 
Payments(240)(146)
Ending balance$295 $331 

Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three months ended March 31, 20212022 and 20202021 for product shipped in previous periods were not material.

Actual global product returns were approximatelyless than 1% and 2%1% of net revenue for the three months ended March 31, 20212022 and 2020,2021, respectively.

20212022 Q1 Form 10-Q | 11
elan-20220331_g1.jpg

Table of Contents
Disaggregation of Revenue

In the first quarter of 2021, management revisited how it analyzesThe following table summarizes our revenue both internally and externally, and determined that disaggregationdisaggregated by major product line provides a more meaningful view of our results. Accordingly, we updated our disaggregated revenue presentation from the previous five categories (i.e., pet health disease prevention, pet health therapeutics, farm animal future protein & health, farm animal ruminants & swine, and contract manufacturing) to the following:category:
Three Months Ended March 31,
20212020
Three Months Ended March 31,
20222021
Pet HealthPet Health$645 $206 Pet Health$639 $645 
Farm AnimalFarm Animal578 433 Farm Animal569 578 
Contract Manufacturing (1)
Contract Manufacturing (1)
19 19 
Contract Manufacturing (1)
17 19 
RevenueRevenue$1,242 $658 Revenue$1,225 $1,242 
(1)Represents revenue from arrangements in which we act asmanufacture products on behalf of a contract manufacturer,third party, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.

Note 4.5. Acquisitions and Divestitures

Bayer Animal HealthKindredBio Acquisition

On August 1, 2020,27, 2021, we completedacquired KindredBio, a publicly traded biopharmaceutical company that develops innovative biologics focused on saving and improving the lives of pets. The acquisition further accelerates our previously announced acquisition of Bayer Animal Health, a provider of products intended to improve thepet health and well-being of pets and farm animals,expansion, particularly by expanding our presence in a cash and stock transaction. dermatology.

The transaction was accounted for as a business combination under the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The determination of estimated fair value requires management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of Bayer Animal Health arethe acquisition is included in our condensed consolidated financial statements from the date of acquisition.

The acquisition has expandedIn connection with the merger agreement, we acquired all outstanding stock of KindredBio for $9.25 per share, or an aggregate cash purchase consideration of $444 million. We utilized our pet health product category, advancing our planned portfolio mix transformationrevolving credit facility and creating a better balance between our farm animal and pet health product categories. Our existing product portfolio and pipeline have been enhanced bycash on hand to finance the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure while expanding our directacquisition. Refer to retailer/e-commerce presence.
Total consideration transferred to Bayer and its subsidiariesNote 9: Debt for the acquisition is summarized as follows:
Cash consideration (1)
$5,058 
Fair value of Elanco common stock (2)
1,724 
Fair value of total consideration transferred (3)
$6,782 
further details.

(1)Includes initial cash considerationOn May 5, 2021, we signed an agreement with KindredBio to acquire exclusive global rights to KIND-030, a monoclonal antibody that is being developed for the treatment and prevention of $5,170 million less working capital and tax adjustments of $112 million.
(2)Representscanine parvovirus. We calculated the acquisition date fair value of 73the liability associated with that agreement using an income approach leveraging the estimated sales royalty, sales milestone and technical milestone payments avoided, and settled the $26 million shares of Elanco common stock at $23.64 per share. Per the terms of the stock and asset purchase agreement, the number of shares was based on approximately $2.3 billion divided by the 20-day volume-weighted average stock price as of the last day of trading beforeliability upon the closing of theour acquisition (but subjectof KindredBio. Refer to a 7.5% symmetrical collar centered on the baseline share number of approximately $2.3 billion divided by an initial share price of $33.60).
(3)The purchase price is preliminaryNote 6: Asset Impairment, Restructuring and subject to certain minor customary purchase price adjustments.Other Special Charges for further discussion.

We recognized transaction costs related to the acquisition of Bayer Animal Health of $3 millionRevenue and $20 million during the three months ended March 31, 2021 and 2020, respectively. These costs were primarily associated with financial advisory, legal and other professional services related to the acquisition and are reflected within asset impairment, restructuring and other special chargesloss from KindredBio included in our condensed consolidated statements of operations.

The amount of revenue attributable to Bayer Animal Health included in our condensed consolidated statement of operations for the three months ended March 31, 2021 is $559 million. Based on our current operational structure,2022 were immaterial.

20212022 Q1 Form 10-Q | 12
elan-20220331_g1.jpg

Table of Contents
we have not recorded standalone costs for Bayer Animal Health after the date of the acquisition. As a result, we are unable to accurately determine earnings or loss attributable to Bayer Animal Health since the date of acquisition.

The valuation of assets acquired and liabilities assumed has not yet been finalized as of March 31, 2021. The purchase price allocation is preliminary and subject to change, including the valuation of inventories, property and equipment, intangible assets, income taxes and goodwill, among other items. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the acquisition date. During the three months ended March 31, 2021, we recorded immaterial measurement period adjustments which were made to reflect the facts and circumstances in existence as of the acquisition date. These adjustments primarily related to changes in inventory balances and gross margin assumptions as well as minor working capital adjustments. The fair values in the table below have been updated to reflect these measurement period adjustments. Finalization of the valuation during the measurement period could result in additional changes in the amounts recorded for the acquisition date fair value.

The following table summarizes the preliminary fair value ofamounts recognized for assets acquired and liabilities assumed as of the acquisition date:

Estimated Fair Value at August 1, 202027, 2021
Cash and cash equivalents$16931 
Accounts receivableOther net working capital9
Inventories487 
Prepaid expenses and other current assets57 
Property and equipment34733 
Intangible assets:assets, primarily acquired in-process research and development (IPR&D)339 
Acquired in-process research and development65 
Marketed products3,930 
Assets held for sale138 
Accounts payable and accrued liabilities(240)
Accrued retirement benefits(217)
Other noncurrent assets and liabilities,Deferred income taxes, net(894)(23)
Total identifiable net assets3,851389 
Goodwill2,93129 
Settlement of liability related to previous license agreement26 
Total consideration transferred$6,782444 

Inventories comprisedThe accounting for this acquisition is substantially complete, with the exception of $314 million, $79 million, $94 millionthe finalization of the valuation of intangible assets, tax-related amounts and minor working capital adjustments. The measurement period adjustments recorded during 2022, which were made to reflect the facts and circumstances in finished products, workexistence as of the acquisition date, primarily related to changes in process, and raw materials, respectively. The preliminary estimate ofthe estimated fair value of finished productsacquired IPR&D and minor tax and working capital adjustments. The net impact of these adjustments was determined based on net realizable value adjusteda decrease of $4 million to goodwill. Finalization of the valuation during the measurement period could result in a change in the amounts recorded for the costs to completeacquisition date fair value. The completion of the sales process, a reasonable profit allowancevaluation will occur no later than one year from the sales process, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the sales process, a reasonable profit allowance for the remaining manufacturing and sales process effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value. The net fair value step-up adjustment to inventories of $148 million has been amortized to cost of sales as the inventory is sold to customers. As of March 31, 2021, the fair value step-up adjustment has been fully amortized.acquisition date.

Property and equipment is mostly composedcomprised of land, buildings, equipment (including machinery,laboratory equipment, furniture and fixtures, and computer equipment), and construction in progress. The preliminary estimate ofestimated fair value of real and personal property was determined using the sales comparison data valuation technique, andto the preliminary estimate of fair value of personal propertyextent that market data for similar assets was determined usingavailable. When market pricing data was not available for a given asset or asset class, the direct replacement cost method. The recorded fair value of property and equipment located at the Shawnee, Kansas site is currently equal to its net book value at the time of the acquisition, as we are in the process of gathering information to finalize our fair value assessment.method was used.

Intangible assets relate to $65 million of in-process research and development (IPR&D) and $3,930 million of marketed products. The acquired definite-lived intangible assets are being amortized over a weighted-average
2021 Q1 Form 10-Q | 13
elan-20210331_g1.jpg

estimated useful life of approximately 10 years on a straight-line basis. The estimated fair values of identifiable intangible assetsacquired IPR&D were determined using the "incomeincome approach," which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product (including revenues, cost of sales, R&D expenses, marketing, selling and administrative expenses, and contributory asset charges), the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, and competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of intangible assets as of March 31, 2021 is based on preliminary assumptions which are subject to change as we complete our valuation procedures.
Assets held for sale include $133 million of intangible assets, consisting of marketed products and IPR&D, and $5 million of inventory related to the divestitures of Drontal™, Profender™ and other products. In order to secure the necessary regulatory clearances for the acquisition of Bayer Animal Health, we signed agreements to divest the rights to the Drontal and Profender product families within the United Kingdom and European Economic Area as well as other IPR&D. We completed the transactions, which were accounted for as asset divestitures, in the third quarter of 2020.

Accrued retirement benefits primarily relate to certain Bayer Animal Health international subsidiaries that have underfunded defined benefit pension plans. We have recorded the fair value of these plans using assumptions and accounting policies similar to those disclosed in Note 19: Retirement Benefits to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020. Upon acquisition, the excess of projected benefit obligation over the fair value of plan assets was recognized as a liability and previously existing deferred actuarial gains and losses and unrecognized service costs or benefits were eliminated.

The goodwill recognized from this acquisition represents the value of additional growth platformsis primarily attributable to KindredBio's assembled workforce and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization.expected synergies. The majority of goodwill associated with this acquisition is not deductible for tax purposes.

Pro forma financial information (unaudited)

The following table presents the estimated unaudited pro forma combined results of Elanco and Bayer Animal Health for the three months ended March 31, 2020 as if the acquisition of Bayer Animal Health had occurred on January 1, 2020:

Revenue$1,170 
Loss before income taxes(67)

The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Elanco and Bayer Animal Health. The supplemental pro forma financial information does not necessarily represent what the combined companies' revenue or results of operations would have been had the acquisition been completed on January 1, 2020, nor is it intended to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Elanco and Bayer Animal Health.

The unaudited supplemental pro forma financial information reflects primarily pro forma adjustments related to divestitures, fair value estimates for intangibles and inventory, and interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition of Bayer Animal Health. The unaudited supplemental pro forma financial information includes transaction charges associated with the acquisition. There are no material, nonrecurring pro forma adjustments directly attributable to the acquisition included in the reported pro forma revenue and loss before income taxes.



20212022 Q1 Form 10-Q | 1413
elan-20220331_g1.jpg

Table of Contents
Divestitures and Assets Held For Sale

Shawnee and Speke divestitures

During 2021, as part of our strategy to optimize our manufacturing footprint, we announced an agreement with TriRx Pharmaceuticals (TriRx) to sell our manufacturing sites in Shawnee, Kansas and Speke, U.K. (Speke), including the planned transfer of approximately 600 employees. In connection with advancing our efforts to secure the necessary regulatory clearances for our acquisition of Bayer Animal Health,these arrangements, we signedalso entered into long-term manufacturing and supply agreements, in 2020 to divest the rights tounder which TriRx will manufacture and commercialize certain products, including currently marketed products and certain IPR&D assets. As part of those transactions, we signed an agreement to divest the worldwide rights to the legacyexisting Elanco products Itrafungol™ and Clomicalm™ in connection withat both sites upon the required disposal of an early-stage IPR&D asset. We also made a payment during the three months ended March 31, 2021 and accrued for future amounts we are required to pay to the buyerclosing of the IPR&D assettransactions. On August 1, 2021, we completed the sale of our Shawnee site and expect to help fund their development costs forreceive gross cash proceeds of $51 million over a set period of time.three years based on the terms of the agreement, beginning in the second half of 2022. On February 1, 2022, we completed the sale of our Speke site and expect to receive gross cash proceeds of $32 million over a period of one year commencing 12 months from the closing date. Receivables for the expected cash proceeds are included in other receivables and other noncurrent assets on our condensed consolidated balance sheets. Upon closing, we recorded a contract asset of $55 million for the favorable supply agreement, which is included in prepaid expenses and other and other noncurrent assets on our condensed consolidated balance sheets. The related assets met the assetsfor Speke were classified as held for sale criteria as of December 31, 2020.2021. The divestiture closed during the three months ended March 31, 2021. There were no proceeds received from the disposition of these assetsdivestitures did not represent a strategic shift that has or will have a major effect on our operations and the resulting immaterial impact was recorded in other expense, net in our condensed consolidated statement of operations.financial results, and therefore does not qualify for reporting as a discontinued operation. See Note 6: Asset Impairment, Restructuring and Other Special Charges for further information.

Assets Held For Sale

Assets and liabilities considered held for sale in connection with the above divestituredivestitures were included in the respective line items on theour condensed consolidated balance sheetsheets as follows:
December 31, 20202021
Inventories$231 
Other intangibles, net4 
Property and equipment, net050 
Deferred tax asset1 
Total assets held for sale$781 

Other intangibles,Subsequent Transactions

Microbiome R&D platform carve-out

In April 2022, we signed an agreement to transfer assets associated with our microbiome R&D platform to a newly created, independent biopharmaceutical company, BiomEdit, focused on developing solutions for animal and human health. As part of the agreement, we will retain a non-voting, minority stake in the company. Assets transferred include intellectual property and laboratory equipment. The book values of those assets were not material. In addition, we have entered into transitional services agreements with the company for certain services. We have determined that the disposal of the related net classifiedassets does not qualify for reporting as helda discontinued operation because it does not represent a strategic shift that has or will have a major effect on our operations and financial results. The accounting for this transaction is not yet complete, but we expect to record a gain on the disposal in the second quarter of 2022. While there is no certainty that additional equity in BiomEdit will be sold, the sale primarily consisted of marketed products.additional Series A equity by the company during 2022 could result in additional gains.

Note 5.6. Asset Impairment, Restructuring and Other Special Charges

In recent years, we have incurred substantial costs associated with restructuring programs and cost-reduction initiatives designed to achieve a flexible and competitive cost structure. RestructuringAs discussed further below, restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions, including the acquisition of Bayer Animal Health, we have also incurred costs associated with executing transactions and integrating acquired operations, which may include expenditures for banking, legal, accounting, and other similar services. In addition, we have incurred costs to stand up our organization as an independent company. All operating functions can be impacted by these actions; therefore, non-cash expenses associated with our tangible and intangible assets can be incurred as a result of revised fair value projections and/or determinations to no longer utilize certain assets in the business on an ongoing basis.

2022 Q1 Form 10-Q | 14
elan-20220331_g1.jpg
Table of Contents
For finite-lived intangible assetassets and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 1:2: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
2021 Restructuring Programs

In 2021, we announced 2 separate restructuring programs to improve operating efficiencies.
2021 Q1 Form 10-Q | 15
elan-20210331_g1.jpg

The actions proposed in January 2021 focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we closed our R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We have also reduced duplication and optimized structures in U.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring resulted in the elimination of approximately 315 positions around the world. Activities related to this initiative resulted in net charges of $41 million for the three months ended March 31, 2021, primarily consisting of severance costs and other non-cash charges. Restructuring charges under this program were substantially complete at the end of 2021.

The program announced in November 2021 includes initiatives to consolidate certain international commercial operations into one organization, integrate our centralized global marketing organization into country level commercial organizations, transform and simplify our R&D organizational structure, and other organizational adjustments. In connection with the proposed restructuring, we expect to eliminate approximately 380 positions. During the three months ended March 31, 2022, we recorded adjustments of $7 million to reduce severance accruals resulting from final negotiations and certain restructured employees filling open positions. Restructuring charges under this program were substantially complete as of March 31, 2022; however, we may continue to make adjustments to our severance accruals to reflect changes in estimates resulting from ongoing negotiations.

Components of asset impairment, restructuring and other special charges are as follows:
Three Months Ended March 31,
20212020
Restructuring charges:
Severance and other costs (1)
$26 $1 
Facility exit costs (1)
0 1 
Acquisition related charges:
Transaction and integration costs (2)
81 76 
Non-cash and other items:
Asset impairment (3)
9 0 
Asset write-down (4)
2 1 
Gain on sale of fixed assets (5)
0 (4)
Settlements and other (6)
(10)0 
Total expense$108 $75 

Three Months Ended March 31,
20222021
Restructuring charges (credits):
Severance and other costs (1)
$(7)$26 
Facility exit costs1 — 
Acquisition related charges:
Transaction and integration costs (2)
24 81 
Non-cash and other items:
Asset impairment (3)
— 9 
Asset write-down (4)
28 2 
Net periodic benefit cost (credits) (Note 14)— (9)
Settlements and other— (1)
Total expense$46 $108 
(1)For2022 credits primarily related to adjustments resulting from the three months ended March 31,reversal of severance accruals associated with the November 2021 theseprogram. 2021 charges primarily relate tomainly represent employee termination costs for the restructuring program announced and initiated in January 2021, partially offset by a $13 million reversal of severance accruals associated with a restructuring program announced and initiated in January 2021. These costs were partially offset by the reversal of severance accruals under the September 2020 program that are no longer needed. See below for further details.2020.
For the three months ended March 31, 2020, these charges primarily relate to the announced 2019 program to streamline operations in Speke, England as well as the remaining costs to close the Larchwood, Iowa facility.
(2)Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services. Integration costs represent internal and external incremental costs directly related to integrating acquired businesses, including the acquisitionacquisitions of KindredBio and Bayer Animal Health (e.g., expenditures for consulting, system and process integration, and product transfers), as well as independent company stand-up costs related to the implementation of new systems, programs, and processes.
(3)Asset impairment charges for the three months ended March 31, 2021 related to an adjustment to fair value of intangible assets that were subject to product rationalization.
(4)Asset write-down expenses for the three months ended March 31, 2021 resulted from adjustments recorded to write assets classified as held and used down to their current fair value. These included charges related to fixed assets in Basel, Switzerland; Cuxhaven, Germany; and Manukau, New Zealand in connection with announced restructuring programs.
Asset write-down expenses for the three months ended March 31, 2020 resulted from adjustments recorded to write assets classified as held and used down to their current fair value. These charges primarily related to fixed assets in Wusi, China in connection with the announced 2019 program to streamline operations.
(5)Represents a gain on the disposal from the sale of an R&D facility in Prince Edward Island, Canada.
(6)As a result of workforce reductions in connection with our September 2020 and January 2021 restructuring programs, we remeasured the impacted pension benefit obligations as of March 31, 2021, which resulted in a curtailment gain. See Note 13: Retirement Benefits for further information. This amount also includes the gain recorded on the divestiture of an early-stage IPR&D asset acquired as part of the Bayer Animal Health acquisition.

In January 2021, we announced a restructuring aligned with our ongoing efforts to improve operating efficiencies. The proposed actions are focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we intend to close R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We will also reduce duplication and optimize structures in U.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring will result in the elimination of approximately 330 positions around the world. Charges related to this initiative were approximately $41 million for the three months ended March 31, 2021. The overall project is expected to be substantially complete by the end of 2021.

In September 2020, following the closing of the Bayer Animal Health acquisition, we implemented a restructuring program designed to reduce duplication, drive efficiency and optimize our footprint in key geographies. As part of the restructuring plan, we have eliminated approximately 900 positions across 40 countries, primarily in the commercial and marketing functions, but also in R&D, manufacturing and quality, and back office support functions.
20212022 Q1 Form 10-Q | 1615
elan-20220331_g1.jpg

Table of Contents
During(3)Represents the three months ended March 31, 2021 we recorded a favorable adjustmentimpact of $13 million as a change in estimate related to this initiative, which reflects adjustments to severance accruals resulting from favorable negotiationsfair value of property and certain restructured employees filling open positions. The overall project is expectedequipment, IPR&D assets, and marketed products that were subject to be substantially complete byproduct rationalization.
(4)2022 includes the endfinalization of 2021.the write-down charge upon the final sale of the Speke site. See Note 5: Acquisitions and Divestitures for further discussion. 2021 represents the impact of changes in the estimated useful lives of assets involved in restructuring actions and adjustments recorded to write assets classified as held and used down to their current fair value.

The following table summarizes the activity in our reserves established in connection with restructuring activities:
Facility exit costsSeveranceTotal
Balance at December 31, 2019$5 $16 $21 
Charges1 1 2 
Reserve adjustments0 (1)(1)
Cash paid(1)(10)(11)
Balance at March 31, 2020$5 $6 $11 
Balance at December 31, 2020$0 $130 $130 
Charges0 39 39 
Reserve adjustments0 (13)(13)
Cash paid0 (38)(38)
Balance at March 31, 2021$0 $118 $118 

Severance
Balance at December 31, 2020$130 
Charges39 
Reserve adjustments(13)
Cash paid(38)
Balance at March 31, 2021$118 
Balance at December 31, 2021$126 
Reserve adjustments(7)
Cash paid(43)
Balance at March 31, 2022$76 
These reserves are included in other current and noncurrent liabilities on theour condensed consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next 1812 months primarily due to certain country negotiations and regulations. We believe that the reserves are adequate.

Note 6.7. Inventories

We state all inventories at the lower of cost or net realizable value. We use the last-in, first-out (LIFO) method for a portion of our inventories located in the continental U.S. Other inventories are valued by the first-in, first-out (FIFO) method or the weighted average cost method.

Inventories consisted of the following:
March 31, 2021December 31, 2020
Finished products$613 $772 
Work in process630 625 
Raw materials and supplies211 210 
Total1,454 1,607 
Decrease to LIFO cost(30)(29)
Inventories$1,424 $1,578 
March 31, 2022December 31, 2021
Finished products$603 $598 
Work in process572 565 
Raw materials and supplies219 256 
Total1,394 1,419 
Decrease to LIFO cost(49)(46)
Inventories$1,345 $1,373 

Note 7.8. Equity

Common Stock Offering

On January 22, 2020, we entered into an underwriting agreement in which we agreed to sell approximately 23 million shares of our common stock at a public offering price of $32.00 per share. In connection with the offering, we granted the underwriters an option to purchase up to an additional 2 million shares, which was exercised in full on January 23, 2020. As a result, we issued and sold a total of approximately 25 million shares of our common stock for $768 million, after issuance costs.

2021 Q1 Form 10-Q | 17
elan-20210331_g1.jpg

Tangible Equity Unit (TEU) Offering

On January 22, 2020, we also completed our offering of 11 million, 5.00% TEUs. Total proceeds, net of issuance costs, were $528 million. Each TEU, which has a stated amount of $50, is comprised of a prepaid stock purchase contract (prepaid stock) and a senior amortizing note due February 1, 2023. Subsequent to issuance, each TEU may be legally separated into the two components. The prepaid stock is considered a freestanding financial instrument, indexed to Elanco common stock, and meets the conditions for equity classification.

The value allocated to the prepaid stock is reflected net of issuance costs in additional paid-in capital. The value allocated to the senior amortizing notes is reflected in current portion of long-term debt on the condensed consolidated balance sheet, with payments expected in the next twelve months reflected in current portion of long-term debt.sheets. Issuance costs related to the amortizing notes are reflected as a reduction of the carrying amount and will be amortized through the maturity date using the effective interest rate method.
2022 Q1 Form 10-Q | 16
elan-20220331_g1.jpg
Table of Contents

The proceeds from the issuance were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
Equity ComponentDebt ComponentTotal
Fair value per unit$42.80 $7.20 $50.00 
Gross proceeds$471 $79 $550 
Less: Issuance costs19 3 22 
Net proceeds$452 $76 $528 

The senior amortizing notes have an aggregate principal amount of $79 million and bear interest at 2.75% per year. On each February 1, May 1, August 1, and November 1 until the maturity date, we will pay equal quarterly cash installments of $0.6250 per each amortizing note with an initial principal amount of $7.2007 (except for the first installment payment of $0.6528 per amortizing note paid on May 1, 2020). Each installment constitutes a payment of interest and partial payment of principal, and in the aggregate will be equivalent to 5.00% per year with respect to the $50 stated amount per TEU.

Unless settled early at the holder’s or our election, each prepaid stock purchase contract will automatically settle on February 1, 2023 (the mandatory settlement date) for a number of shares of common stock per contract based on the average of the volume-weighted average trading prices during the 20 consecutive trading day period beginning on, and including the 21st scheduled trading day immediately preceding February 1, 2023 (applicable market value) with reference to the following settlement rates:
Applicable Market ValueCommon Stock Issued
Equal to or greater than $38.401.3021 shares (minimum settlement rate)
Less than $38.40, but greater than $32.00$50 divided by applicable market value
Less than or equal to $32.001.5625 (maximum settlement rate)

The prepaid stock purchase contracts are mandatorily convertible into a minimum of 14 million shares or a maximum of 17 million shares of our common stock on the mandatory settlement date (unless redeemed by us or settled earlier at the unit holder's option). The 14 million minimum shares are included in the calculation of basic weighted average shares outstanding. The difference between the minimum and maximum shares represents potentially dilutive securities, which are included in the calculation of diluted weighted average shares outstanding on a pro rata basis to the extent that the average applicable market value is higher than $32.00 but is less than $38.40 during the period. The entire additional 3 million shares are included in diluted weighted average shares outstanding if the applicable market value is at or below $32.00 and the impact is not anti-dilutive.

20212022 Q1 Form 10-Q | 1817
elan-20220331_g1.jpg

Table of Contents
Note 8.9. Debt

Long-term debt consisted of the following:
March 31, 2021December 31, 2020March 31, 2022December 31, 2021
Term loan B credit facility$4,151 $4,164 
Revolving credit facility50 0 
3.912% Senior Notes due 2021500 500 
Incremental Term FacilityIncremental Term Facility$497 $499 
Term Loan BTerm Loan B4,038 4,118 
Revolving Credit FacilityRevolving Credit Facility150 250 
4.272% Senior Notes due 20234.272% Senior Notes due 2023750 750 4.272% Senior Notes due 2023750 750 
4.900% Senior Notes due 20284.900% Senior Notes due 2028750 750 4.900% Senior Notes due 2028750 750 
TEU amortizing notes53 60 
Other obligations0 1 
TEU Amortizing NotesTEU Amortizing Notes27 34 
Unamortized debt issuance costsUnamortized debt issuance costs(93)(98)Unamortized debt issuance costs(78)(82)
6,161 6,127 6,134 6,319 
Less current portion of long-term debtLess current portion of long-term debt605 555 Less current portion of long-term debt61 294 
Total long-term debtTotal long-term debt$5,556 $5,572 Total long-term debt$6,073 $6,025 
Farm Credit Agreement

On August 12, 2021, we entered into a new debt financing arrangement with Farm Credit Mid-America, PCA (Farm Credit) for a $500 million credit facility, consisting of a senior secured term loan (Incremental Term Facility) to retire our Senior Notes that were due August 27, 2021. The Incremental Term Facility bears interest at a floating rate of LIBOR plus 175 basis points and is payable in quarterly installments of principal and interest with a final balloon payment due on August 12, 2028. The terms of the Incremental Term Facility, including pledged collateral and financial maintenance covenants, are generally consistent with the terms of our existing term loan B credit facility (Term Loan B) and revolving credit facility.

Bayer Animal Health Related Financing

In connection with the acquisition of Bayer Animal Health, on August 1, 2020, we borrowed $4,275 million under a term loanTerm Loan B credit facility. The term loanTerm Loan B facility bears interest at a floating rate of LIBOR plus 175 basis points over a seven-year term.and is payable in quarterly installments through August 1, 2027.
Simultaneously, we entered into a revolving credit facility providing up to $750 million (with incremental capacity available if certain conditions are met) and maturing over a five-yearfive-year term. The revolving credit facility bears interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating. In February 2021, we drew down $150 million on the revolving credit facility for working capital needs. We subsequently repaid $100 million in March 2021 and the remaining $50 million in April 2021.
These senior secured first lien credit facilities are secured by a significant portion of our assets. They include 2 financial maintenance covenants which are solely for the benefit of lenders under the revolving credit facility. There are 0no financial maintenance covenants for the benefit of the term loanTerm Loan B facility. The lenders under the term loanTerm Loan B facility have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.

The first financial maintenance covenant for the revolving credit facility requires us to maintain a net total leverage ratio level (which is not subject to step-downs) as of the end of each quarter. The required level of this covenant is based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) not exceeding 7.71 to 1.00 of our pro forma adjusted EBITDA for the four fiscal quarters ended March 31, 2021.2022.

The second financial maintenance covenant for the revolving credit facility requires us to maintain a ratio of pro forma adjusted EBITDA to cash interest expense of no less than 2.00 to 1.00, tested as of the end of each fiscal quarter. We were in compliance with all covenants under the credit facility as of March 31, 2021.2022.

2022 Q1 Form 10-Q | 18
elan-20220331_g1.jpg
Table of Contents
Senior Notes

In August 2018, we issued $2 billion of senior notes (Senior Notes). The Senior Notes are comprised of $500 million of 3.912% Senior Notes due August 27, 2021, which were fully repaid as part of the Farm Credit refinancing, $750 million of 4.272% Senior Notes due August 28, 2023, and $750 million of 4.900% Senior Notes due August 28, 2028. The interest rate payable on each series of Senior Notes is subject to adjustment if Moody's Investor Services, Inc. or Standard & Poor's Financial Services LLC downgrades, or subsequently upgrades, its ratings on the respective series of Senior Notes.
2021 Q1 Form 10-Q | 19
elan-20210331_g1.jpg

The indenture that governs the Senior Notes contains covenants including limitations onthat limit our, ability, and certain of our subsidiaries,subsidiaries' ability, to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets, in addition to other customary terms. We were in compliance with all such covenants under the indenture governing the Senior Notes as of March 31, 2021.2022.
In April 2022, we completed a tender offer and retired $406 million in aggregate principal amount of our 4.272% Senior Notes due August 28, 2023, resulting in a debt extinguishment loss of approximately $17 million to be recognized in interest expense, net of capitalized interest in the condensed consolidated statements of operations during the second quarter of 2022. The repayment was funded with proceeds received from a draw under our revolving credit facility.

Also in April 2022, we entered into an incremental assumption agreement with Farm Credit, supplementing and amending our existing credit agreement dated August 1, 2020. The incremental assumption agreement provides for a new incremental term facility with an aggregate principal amount of $250 million maturing on April 19, 2029. The proceeds were used to repay a portion of our outstanding obligations under our revolving credit facility. The new incremental term facility, including the interest rate and repayment terms, are generally consistent with the terms of our existing Term Loan B.

TEU Amortizing Notes

On January 22, 2020, we issued $550 million in TEUs. We offered 11 million, 5.00% TEUs at the stated amount of $50 per unit, comprised of prepaid stock purchase contracts and a senior amortizing note due February 1, 2023 (the mandatory settlement date). Total cash of $528 million was received, comprised of $452 million of prepaid stock purchase contracts and $76 million of senior amortizing notes, net of issuance costs. WeDuring the three months ended March 31, 2022, we paid $7 million representing partial payment of principal and interest on the TEU amortizing notes during the three months ended March 31, 2021.notes. See Note 7:8: Equity for further information.

Debt Extinguishment

On January 31, 2020, we repaid indebtedness outstanding under our previous term loan facility. We paid $372 million in cash, composed of $371 million of principal and $1 million of accrued interest, resulting in a debt extinguishment loss of $1 million (recognized in interest expense, net of capitalized interest in the condensed consolidated statement of operations for the three months ended March 31, 2020), primarily related to the write-off of deferred debt issuance costs.

Note 9.10. Financial Instruments and Fair Value

Financial instruments that are potentially subject to credit risk consist principally of trade receivables. We evaluate the creditworthiness of our customers on a regular basis, monitor economic conditions, and calculate allowances for estimated credit losses on our trade receivables on a quarterly basis using an expected credit loss model. We assess whether collectability is probable at the time of sale and on an ongoing basis. Collateral is generally not required. The risk associated with this concentration is mitigated by our ongoing credit-review procedures.

A large portion of our cash is held by a few major financial institutions. We monitor the exposure with these institutions and do not expect any of these institutions to fail to meet their obligations. All highly liquid investments with a maturity of three months or less from the date of purchase are considered to be cash equivalents. The cost of these investments approximates fair value. We also consider the carrying value of restricted cash balances to be representative of its fair value.

As of March 31, 2021We had investments without readily determinable fair values and December 31, 2020, we had $34 million and $33 million, respectively, ofequity method investments included in other noncurrent assets on our condensed consolidated balance sheet. These include investments with readily determinable fair values, investments without readily determinable fair values,sheets totaling $23 million and equity method investments.$22 million as of March 31, 2022 and December 31, 2021, respectively. Unrealized net gains and losses duringon our investments for the three months ended March 31, 20212022 and March 31, 20202021 were immaterial.

20212022 Q1 Form 10-Q | 2019
elan-20220331_g1.jpg

Table of Contents
The following table summarizes the fair value information at March 31, 20212022 and December 31, 20202021 for foreign exchange contract assets (liabilities), contingent consideration liabilities,investments, and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items, as well as long-term debt (including TEU amortizing notes) for which fair value is disclosed on a recurring basis:
  Fair Value Measurements Using 
Financial statement line itemCarrying
Amount		Quoted Prices in Active Markets for Identical Assets
(Level 1)		Significant
Other Observable Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)		Fair
Value
March 31, 2021
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments$22 $0 $22 $0 $22 
Other current liabilities - foreign exchange contracts not designated as hedging instruments(45)0 (45)0 (45)
Other noncurrent liabilities - contingent consideration(1)0 0 (1)(1)
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges(23)0 (23)0 (23)
Long-term debt - senior notes(2,000)0 (2,171)0 (2,171)
TEU amortizing note(53)0 (49)0 (49)
Term loan B(4,151)0 (4,125)0 (4,125)
Revolving credit facility (1)
(50)0 (50)0 (50)
December 31, 2020
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments$36 $0 $36 $0 $36 
Other current liabilities - foreign exchange contracts not designated as hedging instruments(36)0 (36)0 (36)
Other noncurrent liabilities - contingent consideration(1)0 0 (1)(1)
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges(76)0 (76)0 (76)
Long-term debt - senior notes(2,000)0 (2,218)0 (2,218)
TEU amortizing notes(60)0 (58)0 (58)
Term loan B(4,164)0 (4,144)0 (4,144)

(1)We consider the carrying value to be representative of its fair value due to the short-term nature of this instrument.

  Fair Value Measurements Using 
Financial statement line itemCarrying
Amount		Quoted Prices in Active Markets for Identical Assets
(Level 1)		Significant
Other Observable Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)		Fair
Value
March 31, 2022
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments$50 $— $50 $— $50 
Prepaid expense and other - forward-starting interest rate contracts designated as cash flow hedges10 — 10 — 10 
Other noncurrent assets - investments10 10 — — 10 
Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges107 — 107 — 107 
Other current liabilities - foreign exchange contracts not designated as hedging instruments(49)— (49)— (49)
Long-term debt, including current portion(6,212)— (6,228)— (6,228)
December 31, 2021
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments$19 $— $19 $— $19 
Other noncurrent assets - investments13 13 — — 13 
Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges8 — 8 — 8 
Other current liabilities - foreign exchange contracts not designated as hedging instruments(20)— (20)— (20)
Long-term debt, including current portion(6,401)— (6,518)— (6,518)
We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities.

Contingent consideration liabilities as of March 31, 2021 and December 31, 2020 related to contingent consideration associated with the acquisitions of Aratana Therapeutics, Inc. (Aratana) and Prevtec Microbia Inc. (Prevtec) during 2019. For Aratana, we will pay up to $12 million in contingent value rights that are dependent on the achievement of a specified milestone as outlined in the merger agreement. For Prevtec, based on the terms of the purchase agreement, we will pay up to $16 million contingent upon the achievement of specific Coliprotec sales
2021 Q1 Form 10-Q | 21
elan-20210331_g1.jpg

milestones by December 31, 2021. The fair value of both contingent consideration liabilities was estimated using the Monte Carlo simulation model and Level 3 inputs including historical revenue, discount rate, asset volatility, and revenue volatility.

Derivative Instruments and Hedging Activities

We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating activities section of the condensed consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing activities section of the consolidated statements of cash flows. Our outstanding positions are discussed below.

2022 Q1 Form 10-Q | 20
elan-20220331_g1.jpg
Table of Contents
Derivatives Not Designatednot designated as Hedgeshedges

We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. These derivative financial instruments primarily offset exposures in the Euro, British pound, CanadianSwiss franc, Brazilian real, Australian dollar, Euro, Japanese yen, Swiss franc (CHF),Canadian dollar, and Chinese yuan. Foreign currency derivatives used for hedging are put in place using the same or like currencies and duration as the underlying exposures and are recorded at fair value with the gain or loss recognized in other expense, net in the condensed consolidated statementstatements of operations. Forward contracts generally have maturities not exceeding 12 months. At March 31, 20212022 and December 31, 2020,2021, we had outstanding foreign exchange contracts with aggregate notional amounts of $1,503$1,099 million and $1,391$1,212 million, respectively.

The amount of net gaingains (losses) on derivative instruments not designated as hedging instruments, recorded in other expense, net arewere as follows:

Three Months Ended March 31,
20212020
Foreign exchange forward contracts (1)
$34 $28 
Three Months Ended March 31,
20222021
Foreign exchange forward contracts (1)
$(8)$34 

(1)These amounts were substantially offset in other expense, net by the effect of changing exchange rates on the underlying foreign currency exposures.

Derivatives Designateddesignated as Hedgeshedges

In October 2018, as a means of mitigatingWe are subject to interest rate risk with regard to our existing floating-rate debt, and we utilize interest rate swap contracts to mitigate the impact of currency fluctuations on our operationsvariability in Switzerland, we enteredcash flows by effectively converting the floating-rate debt into a five-year cross-currencyfixed-rate debt. We recognize any differences between the variable interest rate payments and the fixed interest rate settlements with the swap with a 750 million CHF notional amount, which was designatedcounterparties as a net investment hedge (NIH) against CHF denominated assets (the fair value of which was estimated based on quoted market values of similar hedges and was classified as Level 2). During the three months ended March 31, 2020, approximately 75% of our cross-currency swaps were liquidated for a cash benefit of $27 million (including $2 million in interest). We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020, which was fully liquidated in April 2020. Notwithstanding settlement, gains and losses within accumulated other comprehensive income (loss) will remain in accumulated other comprehensive income (loss) until either the sale or substantial liquidation of the hedged subsidiary.

Gains on the NIH, recognized withinadjustment to interest expense, net of capitalized interest are as follows:

Three Months Ended March 31,
20212020
Cross-currency interest rate swap contracts$0 $6 

Overover the life of the derivative, gains or losses due to spot rate fluctuations were recorded in cumulative translation adjustment in other comprehensive income (loss). The amounts of net gains on interest rate swap contracts, recorded, net of tax, in accumulated other comprehensive income (loss), are as follows:

2021 Q1 Form 10-Q | 22
elan-20210331_g1.jpg

Three Months Ended March 31,
20212020
Cross-currency interest rate swap contracts$0 $23 


Separately, in March 2020, as a means of mitigating variability in cash flows associated with the anticipated term loan B issuance, we executed forward-starting interest rateswaps. We have designated these swaps with a $4.1 billion notional amount, which are designated as cash flow hedges and have maturity dates ranging between 2022 and 2025. These instruments effectively convert floating-rate debt to fixed-rate debt. The cash flow hedges are recordedrecord them at fair value on ourthe condensed consolidated balance sheet, while changessheets. Changes in the fair value of the hedgehedges are recognized in other comprehensive income (loss). Fair value is estimated based on quoted market values of similar hedges and is classified as Level 2. AmountsOur outstanding forward-starting interest rate swaps have maturities ranging between 2022 and 2025 with aggregate notional amounts of $3,550 million and $3,800 million as of March 31, 2022 and December 31, 2021, respectively.

The amounts of net gains on cash flow hedges, recorded, net of tax, in accumulated other comprehensive income (loss) will be recognized in earnings in interest expense, net of capitalized interest when the hedged transaction affects earnings (i.e., when interest payments are accrued on the term loan B). Duringas follows:

Three Months Ended March 31,
20222021
Forward-starting interest rate swaps$109 $53 

There was no tax effect for the three months ended March 31, 2022 and 2021 after the application of the U.S. valuation allowance. See Note 11: Income Taxes for further discussion. In April 2022, we took advantage of market opportunities to restructure our interest rate swap portfolio. We unwound the existing swaps and 2020simultaneously entered into new agreements with the same notional amounts and covering the same tenors. As a result, we recordedreceived a gaincash settlement of $53$132 million (netduring the second quarter of tax expense of $0 after valuation allowance) and a loss of $39 million (net of tax benefit of $11 million), respectively, on the cash flow hedges in other comprehensive loss.2022. Over the next 12 months, we expect to reclassify $28approximately $47 million from accumulated other comprehensive income (loss) toof unrealized gains associated with our cancelled swaps into interest expense, net of capitalized interest due toin the amortizationcondensed consolidated statements of net losses on the interest rate swaps.operations. During the three months ended March 31, 2022 and 2021, we reclassifiedrecognized $3 million and $7 million, respectively, of net losses into interest expense.

2022 Q1 Form 10-Q | 21
elan-20220331_g1.jpg
Table of Contents
Note 10.11. Income Taxes

Income Tax BenefitThree Months Ended March 31,
20212020
Income tax benefit$(19)$(19)
Effective tax rate23.5 %27.6 %
Three Months Ended March 31,
20222021
Income tax expense (benefit)$23 $(19)
Effective tax rate32.1 %23.5 %

We were included in Lilly's U.S. tax examinations by the Internal Revenue Service through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with the IPO,our initial public offering (IPO), the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. The U.S. examination of tax years 2016 - 2018 began in the fourth quarter of 2019 and remains ongoing; therefore, the resolution of this audit period will likely extend beyond the next 12 months.

For the three months ended March 31, 2022, we recognized income tax expense of $23 million. Our effective tax rate of 32.1% differs from the statutory income tax rate largely due to certain research and experimentation costs being capitalized beginning January 1st, 2022, as provided under the Tax Cuts and Jobs Act. This has increased the expected profits in jurisdictions with higher statutory tax rates as well as expected U.S. international tax inclusions, which are partially offset by utilization of net operating losses and valuation allowance release in the U.S.

For the three months ended March 31, 2021, we recognized an income tax benefit of $19 million. Our effective tax rate of 23.5% differs from the statutory income tax rate primarily due to tax-exempt interest income in certain foreign jurisdictions. Income tax benefit was partially offset by a $2 million increase to the valuation allowance on our U.S. federal and state deferred tax assets during the period.

For the three months ended March 31, 2020, we recognized an income tax benefit of $19 million. The effective tax of 27.6% differs from the statutory income tax rate primarily due to a pre-tax loss mainly driven by acquisition and integration costs. In addition, a discrete income tax benefit of $2 million was recognized related to the excess tax benefits for stock-based compensation that vested in the three months ended March 31, 2020.

Note 11.12. Commitments and Contingencies

Legal Matters

On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco Jeffrey Simmons and Todd Young.certain executives. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint.complaint adding additional claims against Elanco, certain executives, and other individuals. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco securities between September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana Therapeutics, Inc.Aratana. We filed a motion to dismiss on January 13, 2021. The timing of the Court's decision is uncertain. We believe the claims made in the
2021 Q1 Form 10-Q | 23
elan-20210331_g1.jpg

case are meritless, and we intend to vigorously defend our position. The process of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolution cannot be predicted.

On October 16, 2020, a shareholder class action lawsuit captioned Safron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives, and other individuals. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the registration statement on Form S-3 dated January 21, 2020 and accompanying prospectus filed in connection with Elanco’s public offering which closed on or about January 27, 2020. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco common stock or 5.00% TEUs issued in connection with the public offering. This case is currently stayed in deference to Hunter v. Elanco Animal Health Inc. We believe the claims made in the case are meritless, and we intend to vigorously defend our position. The process
2022 Q1 Form 10-Q | 22
elan-20220331_g1.jpg
Table of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolution cannot be predicted.Contents

Claims seeking actual damages, injunctive relief, and/or restitution for the allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC, along with other Elanco and Bayer entities, arising out of the use of Seresto™, a non-prescription flea and tick collar for cats and dogs. In March, April, and MayDuring 2021, putative class action lawsuits were filed in state and federal courts in the U.S. alleging that the Seresto collars contain pesticides and other ingredients that can cause serious injury and death to cats and/or dogs wearing the product. The cases mention the existence of incident reports involving humans, but no plaintiff has claimed personal harm from the product. One plaintiff filed a petition before the Judicial Panel on Multidistrict Litigation (JPML). The hearing on the JPML petition took place on July 29, 2021, and a decision was reached to consolidate and transfer all pending lawsuits to the federal court in the Northern District of Illinois. We continue to receive information with respect to potential litigation costs, and we will be taking appropriate steps to defend these class action lawsuits.

Further, a U.S. House of RepresentativeRepresentatives subcommittee chair requested that Elanco to produce certain documents and information related to the Serestocollar and further made a request to temporarily removerecall Seresto collars from the market. We are cooperatingcontinuing to cooperate with the subcommittee and have produced information pursuant to the request. In addition, as

Seresto is a pesticide registered with the Environmental Protection Agency (EPA), we are providing information. A non-profit organization submitted a petition to the EPA regardingrequesting that the agency take action to cancel Seresto’s pesticide registration and suspend the registration pending cancellation. The EPA is considering this petition and asked for public comment. We submitted a comment to the EPA supporting the safety profile of Seresto. All dataData and scientific evaluation used during the product registration process and through pharmacovigilance review supports the product’s positive safety profile and efficacy. Therefore, we believe no removal, recall, or recallcancellation of the pesticide registration is warranted, nor has it been suggested by any regulatory agency. We continue to stand behind the safety profile for Seresto, and it remains available to consumers globally. We continue to receive information with respect to potential litigation costs and the anticipated number of cases, and we will be taking appropriate steps to defend these class action lawsuits.

We are party to various other legal actions in the normal course of business. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality. We accrue for certain liability claims to the extent that it is probable we will incur a loss and we can formulate a reasonable estimate of the costs. As of March 31, 20212022 and December 31, 2020,2021, we had 0no material liabilities established related to litigation as there were no significant claims which were probable and estimable. We have not historically had any significant litigation expense and are not currently subject to a significant claim other than the lawsuits noted above.


Regulatory Matters


On July 1, 2021, we received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We have cooperated in providing documents and information to the SEC and will continue to do so. Management believes that its actions were appropriate.

Other Commitments

As of March 31, 2022, we have a lease commitment that has not yet commenced for our new corporate headquarters in Indianapolis, Indiana. Total minimum lease payments are estimated to be approximately $310 million over a term of 25 years, excluding extensions. Final lease payments may vary depending on the actual cost of certain construction activities. Lease commencement is expected in 2024.

The land for our new corporate headquarters is located in a Tax Increment Finance District, and the project is, in part, funded through Tax Incremental Financing (TIF) through an incentive agreement between us and the City of Indianapolis. The agreement provides for an estimated total incentive of $64 million to be funded by The City of Indianapolis in connection with the future tax increment revenue generated from the developed property. In December 2021, as part of a funding and development agreement entered into between us and the developer, we made a commitment to use the expected TIF proceeds towards the cost of developing and constructing the headquarters. In exchange, the developer has agreed to reimburse us up to the $64 million commitment. The accrued incentive is included in other non-current liabilities on our condensed consolidated balance sheets, which will amortize over the lease term beginning at the commencement date and offset future rent expense.

20212022 Q1 Form 10-Q | 2423
elan-20220331_g1.jpg

Table of Contents
Note 12.13. Geographic Information

We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both pets and farm animals and pets.animals. Consistent with our operational structure, our President and Chief Executive Officer (CEO), as the Chief Operating Decision Maker,chief operating decision maker, makes resource allocation and business process decisions globally across our consolidated business. Strategic decisions are managed globally with global functional leaders responsible for determining significant costs/investments and with regional leaders responsible for overseeing the execution of the global strategy. Our global research and development organization is responsible for development of new products. Our manufacturing organization is responsible for the manufacturing and supply of products and for the optimization of our supply chain. Regional leaders are responsible for the distribution and sale of our products and for local direct costs. The business is also supported by global corporate staff functions. Managing and allocating resources at the global corporate level enables our CEO to assess the overall level of resources available and how to best deploy these resources across functions, product types, regional commercial organizations and research and development projects in line with our overarching long-term corporate-wide strategic goals, rather than on a product or geographic basis. Consistent with this decision-making process, our CEO uses consolidated, single-segment financial information for purposes of evaluating performance, allocating resources, setting incentive compensation targets, as well as forecasting future period financial results.

Our products include Baycox™AviPro™, Cydectin™Baytril™, Denagard™Cydectin™, Maxiban™Catosal™, Optaflexx™Denagard™, Maxiban™, Rumensin™, Tylan™Pulmotil™, and other products for livestock and poultry, as well as Advantage™, Advantix™, Advocate™ (collectivelyAdvocate™ (collectively referred to as the Advantage Family)Family), Credelio™, Duramune™, Duramune™,Galliprant™, Interceptor™Interceptor™ Plus, Seresto, Trifexis™, and other products for pets.

We have a single customer that accounted for 7%10% and 14%7% of revenue for the three months ended March 31, 20212022 and 2020,2021, respectively. Product sales with this customer resulted in accounts receivable of $75$73 million and $87$74 million as of March 31, 20212022 and December 31, 2020,2021, respectively.

We are exposed to the risk of changes in social, political and economic conditions inherent in foreign operations and our results of operations and the value of our foreign assets are affected by fluctuations in foreign currency exchange rates.

Selected geographic area information was as follows:
Three Months Ended March 31,Three Months Ended March 31,
2021202020222021
Revenue—to unaffiliated customers (1)
RevenueRevenue
United StatesUnited States$533 $300 United States$522 $533 
InternationalInternational709 358 International703 709 
RevenueRevenue$1,242 $658 Revenue$1,225 $1,242 

(1)Revenue is attributed to the countries based on the location of the customer.

2021 Q1 Form 10-Q | 25
elan-20210331_g1.jpg

Note 13.14. Retirement Benefits

The following table summarizes net periodic benefit cost (income) relating to our defined benefit pension plans:plans:
Three Months Ended March 31,
20222021
Service cost$4 $5 
Interest cost1 1 
Expected return on plan assets(2)(2)
Amortization of prior service cost(1)(2)
Amortization of net actuarial loss— 1 
Net curtailments and settlements (Note 6)— (9)
Net periodic benefit cost (income)$2 $(6)

Three Months Ended March 31,
20212020
Service cost$5 $3 
Interest cost1 0 
Expected return on plan assets(2)(1)
Amortization of prior service cost(2)(2)
Amortization of net actuarial loss1 1 
Curtailments (Note 5)(9)0 
Net periodic benefit cost$(6)$1 
2022 Q1 Form 10-Q | 24
elan-20220331_g1.jpg

Table of Contents
The components of net periodic benefit cost (income) other than service cost and net curtailments and settlements are included in other expense, net in theour condensed consolidated statements of operations. CurtailmentsNet curtailments and settlements are included in asset impairment, restructuring and other special charges in theour condensed consolidated statements of operations.

Note 14. Loss15. Earnings (Loss) Per Share

We compute basic lossearnings (loss) per share by dividing net lossincome (loss) available to common shareholders by the actual weighted average number of common shares outstanding for the reporting period. Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements and the TEU prepaid stock purchase contracts (see Note 7:8: Equity for further discussion). Diluted earnings per share reflects the potential dilution that could occur if holders of the unvested equity awards and unsettled TEUs converted their holdings into common stock. The weighted average number of potentially dilutive shares outstanding is calculated using the treasury stock method. Potential common shares that would have the effect of increasing diluted earnings per share (or reducing loss per share) are considered to be anti-dilutive and as such, these shares are not included in the calculation of diluted lossearnings (loss) per share.

Basic and diluted lossearnings (loss) per share are calculated as follows:

Three Months Ended March 31,
20212020
Net loss available to common shareholders$(61)$(49)
Determination of shares:
Weighted average common shares outstanding486.7 403.9
Assumed conversion of dilutive common stock equivalents (1)
0 0 
Diluted weighted average shares outstanding486.7 403.9
Loss per share (2)
Basic$(0.12)$(0.12)
Diluted$(0.12)$(0.12)

Three Months Ended March 31,
20222021
Net income (loss) available to common shareholders$48 $(61)
Determination of shares:
Weighted average common shares outstanding488.0 486.7
Assumed conversion of dilutive common stock equivalents (1)
4.2 — 
Diluted weighted average shares outstanding492.2 486.7
Earnings (loss) per share (2)
Basic$0.10 $(0.12)
Diluted$0.10 $(0.12)
(1)During the three months ended March 31, 2021, and 2020, we reported a net loss. Therefore, dilutive common stock equivalents are not assumed to have been issued since their effect is anti-dilutive. As a result, basic and diluted weighted average shares are the same, causing diluted net loss per share to be equivalent to basic net loss per share. For the three months ended March 31, 2022 and 2021, and 2020, approximately 1.60.1 million and 1.84.4 million, respectively, of potential common shares were excluded from the calculation of diluted earnings (loss) per share because their effect was anti-dilutive.
(2)Due to rounding conventions, lossearnings (loss) per share may not recalculate precisely based on the amounts presented within this table.


20212022 Q1 Form 10-Q | 2625
elan-20220331_g1.jpg

Table of Contents
Note 15. Transactions and Agreements with Bayer

While Bayer is no longer considered a related party, we have transacted with Bayer during the period after the acquisition of Bayer Animal Health, including the period in which Bayer was considered a principal owner of Elanco. These transactions primarily related to local country asset purchases and various transitional services agreements (TSAs), contract manufacturing arrangements, and certain lease agreements to ensure business continuity after the acquisition.

For regulatory purposes in certain jurisdictions, consideration was required to be paid locally at closing in addition to amounts paid globally for the acquisition. Pursuant to the stock and asset purchase agreement, Bayer has provided a refund for payment amounts duplicated in these regions. The total amount paid to and received from Bayer during the three months ended March 31, 2021 for these local country asset purchases was approximately $16 million. All local country asset purchases have been completed as of March 31, 2021.




2021 Q1 Form 10-Q | 27
elan-20210331_g1.jpg

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


Management’s discussion and analysis of financial condition and results of operations (MD&A) is intended to assist the reader in understanding and assessing significant changes and trends related to our results of operations and financial position. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying footnotes in Item 1 of Part I of this Quarterly Report on Form 10-Q. Certain statements in this Item 2 of Part I of this Quarterly Report on Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements,"Statements" of this Form 10-Q, in Item 1A, "Risk Factors,"Factors" of Part II of this Quarterly Report on Form 10-Q, and in Item 1A, “Risk Factors,”Factors” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2020,2021, may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements. Further, due to the seasonality of our pet health sales, interim results are not necessarily an appropriate base from which to project annual results.

Overview

Founded in 1954, Elanco is a premierglobal animal health company that innovates, develops manufactures and markets products for pets and farm animals. Headquarteredanimals in Greenfield, Indiana,more than 90 countries. With a heritage dating back to 1954, we are onerigorously innovate to improve the health of animals and to benefit our customers while fostering an inclusive, cause-driven culture for our employees. We operate our business in a single segment directed at fulfilling our vision of enriching the largest animal health companieslives of people through food, making protein more accessible and affordable, and through pet companionship, helping pets live longer, healthier lives.

On August 27, 2021, we acquired KindredBio, a biopharmaceutical company that develops innovative biologics focused on saving and improving the lives of pets. We had previously signed an agreement with KindredBio in the world, with pro forma combined revenuesecond quarter of Elanco and Bayer Animal Health of approximately $4.4 billion2021 to acquire exclusive global rights to KIND-030, a monoclonal antibody in development for the year ended December 31, 2020.treatment and prevention of canine parvovirus. The acquisition of KindredBio further accelerates our opportunity for expansion in pet health, notably by expanding our research efforts in dermatology. See Note 5: Acquisitions and Divestitures to the condensed consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of KindredBio.

On August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our existing product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure. See Note 4:5: Acquisitions and Divestitures to the condensed consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of Bayer Animal Health.

We offer a diverse portfolio of approximately 190200 brands that make us a trusted partner to pet owners, veterinarians and farm animal producers in more than 90 countries.producers. Our products are generally sold worldwide to third-party distributors and independent retailers, and directly to farm animal producers and veterinarians. With the acquisition of Bayer Animal Health, we have expanded our presence in retail and e-commerce channels in order to meet pet owners where they want to purchase.

2022 Q1 Form 10-Q | 26
elan-20220331_g1.jpg
Table of Contents
We operate our business in a single segment directed at fulfilling our vision of food and companionship enriching life – all to advance the liveshealth of animals, people through food, making protein more accessible and affordable and through pet companionship, helping pets live longer, healthier lives. In 2020, we renamed our four primary product categories by replacing "food animal" and "companion animal" with "farm animal" and "pet health," respectively, to better reflect the terminology used by our customers.planet. We advance our vision with the followingby offering of portfolio solutions:products in these two primary categories:

Pet HealthHealth: : Our pet health portfolio is focused on parasiticides, vaccines and therapeutics. We have one of the broadest parasiticide portfolios in the pet health sector based on indications, species and formulations, with products that protect pets from worms, fleas and ticks. Our Seresto and Advantage Family , Advantix, Advocate (collectively referred to as the Advantage Family) products are over-the-counter treatments for the elimination and prevention, respectively, of fleas and ticks, and complement our prescription parasiticide products, Credelio, Interceptor Plus, and Trifexis. Our vaccines portfolio provides differentiated prevention coverage for a number of important pet health risks and is available in the U.S. only. In therapeutics, we have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprant™ product is one of the fastest growing osteoarthritis treatments in the U.S. Additionally, we have products that offer treatment for otitis (ear infections) with Claro™, as well as treatments for certain cardiovascular and dermatology indications.
2021 Q1 Form 10-Q | 28
elan-20210331_g1.jpg

Farm Animal: Our farm animal portfolio consists of products designed to prevent, control and treat health challenges primarily focused on cattle (beef and dairy), swine, poultry, and aquaculture (cold and warm water) production. Our products include medicated feed additives, injectable antibiotics, vaccines, insecticides, and enzymes, among others. We have a wide range of farm animal products, including Rumensin and Baytril™, both of which are used extensively in ruminants (e.g., cattle, sheep and goats) and swine production.. In poultry, our Maxiban product, is a valuable offering for the control and prevention of intestinal disease.
A summary of our 20212022 revenue and net lossincome (loss) compared with the same period in 20202021 is as follows:
Three Months Ended March 31,
(Dollars in millions)20212020
Revenue$1,242 $658 
Net loss(61)(49)

Three Months Ended March 31,
(Dollars in millions)20222021
Revenue$1,225 $1,242 
Net income (loss)48 (61)
Increases or decreases in inventory levels at our channel distributors can positively or negatively impact our quarterly and annual revenue results, leading to variations in quarterly revenues. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the need for certain inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, payment terms we extend, which are subject to internal policies, and procedures and environmental factors beyond our control, including weather conditions and the COVID-19 global pandemic.

Key Trends and Conditions Affecting Our Results of Operations

Industry Trends

The animal health industry, which includes both pets and farm animals, and pets, is a growing industry that benefits billions of people worldwide.

We believe that factors influencing growth in demand for pet medicines and vaccines include:

•increased pet ownership globally;
•pets living longer; and
•increased pet spending as pets are viewed as members of the family by owners.

As demand for animal protein grows, farm animal health is becoming increasingly important. We believe that factors influencing growth in demand for farm animal medicines and vaccines include:

•onetwo in three people needing improved nutrition;
•increased global demand for protein, particularly poultry and aquaculture;
2022 Q1 Form 10-Q | 27
elan-20220331_g1.jpg
Table of Contents
•natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, driving the need for more efficient food production;
•loss of productivity due to farm animal disease and death;
•increased focus on food safety and food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.

Growth in farm animal nutritional health products (enzymes, probiotics and prebiotics) is influenced, among other factors, by demand for antibiotic alternatives that can promote animal health and increase productivity.
We believe that factors influencing growth in demand for pet medicines and vaccines include:
Factors Affecting Our Results of Operations

Russia-Ukraine Conflict
•increased pet ownership globally;
•pets living longer;In February 2022, Russia commenced military action against Ukraine. In response, the U.S. and
•increased pet spending as pets are viewed as members certain other countries imposed significant sanctions and export controls against Russia, Belarus and certain individuals and entities connected to Russian or Belarusian political, business, and financial organizations. The U.S. and certain other countries could impose further sanctions, trade restrictions, and other retaliatory actions if the conflict continues or worsens. The broader consequences of the familyconflict, including related inflationary pressures, geopolitical tensions, additional retaliatory actions taken by owners.the U.S. and other countries, and any counter retaliatory actions by Russia or Belarus in response, including, for example, potential cyberattacks or the disruption of energy exports, are likely to cause regional instability and could materially adversely affect global trade, currency exchange rates, regional economies and the global economy. The situation remains uncertain and it is difficult to predict the impact that the conflict and actions taken in response to the conflict will have on our business; however, they could increase our costs, disrupt our supply chain, reduce our sales and earnings, or otherwise adversely affect our business and results of operations.

As a global animal health leader, we have an obligation to support the health of animals and people. At the center of that work is ensuring access and availability of food. At this time, we are limiting our business in Russia to only the essential products that support these needs, while complying with all imposed sanctions. We do not manufacture products or source any materials from companies in Russia for use in our products, nor do we conduct business with the Russian government. During the three months ended March 31, 2022, revenue to Russian and Ukrainian customers represented approximately 1% of our consolidated revenue. Assets held in Russia as of March 31, 2022 represented less than 1% of our consolidated assets.

COVID-19 Pandemic and Resulting Operating Environment

We continue to closely monitor the impact of the COVID-19 pandemic, including its variants, and the related economic effects on all aspects of our business, including impacts on our operations, supply chain, and customer demand. The extent to which the COVID-19 pandemic may impact our financial condition and results of operations remains uncertain and is dependent on developments that are out of our control, including measures being taken by authorities to mitigate against the spread of COVID-19, such as the recent lockdowns in China, the emergence of new variants and the availability and successful administration of effective vaccines. We cannot predict the impact that the ongoing COVID-19 pandemic will have on our customers, vendors and suppliers; however, the COVID-19 pandemic has had and may continue to have an adverse impact on our business if these parties continue to experience negative effects.

20212022 Q1 Form 10-Q | 2928
elan-20220331_g1.jpg

Table of Contents
Factors Affecting Our Results of Operations

COVID-19 Pandemic

Our business has been impacted byWhile the situation surrounding the COVID-19 pandemic that originatedremains fluid, the effects have disrupted the global supply chain across all modes of transportation, which in December 2019.turn has resulted in less reliable transportation schedules and increased freight costs. This disruption, combined with increased demand for key raw materials, including those used in COVID-19 vaccine manufacturing, has also impacted our suppliers, resulting in shortages of raw materials or components required to manufacture our products. We continue to monitor the global outbreak of COVID-19 and have workedwork closely with our customers, employees, suppliers and other stakeholdersfreight partners to mitigate the risks posed by its spread. The COVID-19 pandemic continues to impact the economy in the United States and globally, and has had an effect on the operations of our company, vendors and suppliers, and supply of and demand for our products as follows:

Operations

As a result of the COVID-19 pandemic, governmental authorities implemented measures to try to contain the virus, such as travel bans and restrictions, limits on gatherings, quarantines, shelter-in-place orders, site closures and business shutdowns. These measures have affected the ability of our employees, vendors, and suppliers to perform their respective responsibilities and obligations relative to the conduct of our business. We have important manufacturing operations worldwide that have been impacted by the outbreak. Measures requiring business shutdowns generally exclude certain essential services, and those essential services commonly include critical infrastructure and the businesses that support that critical infrastructure. Because the animal health industry has been designated an essential business, our manufacturing and research facilities remain operational, while our employees in other company functions continue to primarily work remotely. These measures have impacted and may further impact our workforce and operations, as well as those of our customers, vendors and suppliers.

Supply

In the first quarter of 2021, we did not experience significant impacts or interruptions to our supply chain as a resultoperations and customers, including the addition of the COVID-19 pandemic. However, as the pandemic continues, we may face supply chain disruptions due to operational difficulties experienced by our suppliers.new transportation routes and targeted increases of certain safety stocks. Although we regularly monitor the financial health of companies in our supply chain, theprolonged financial hardship on our suppliers caused by the COVID-19 pandemicand labor shortages could cause a disruption incontinue to disrupt our ability to obtain key raw materials, or components required to manufacture our products, adversely affecting our operations. Freight processes haveThe global industry freight environment has experienced, and could continue to experience, lead time disruptions and increases in shipping costs, negatively impacting our profitability.

Demand

The COVID-19 pandemic has adversely impacted global economic conditions. In particular, the COVID-19 pandemic created significant uncertainty for our channel distribution partners with respect to end customer demand and working capital, particularly in early 2020. Based on these factors, in addition to a shift in tactics for demand generation with our distributors, in the first and second quarters of 2020, we reduced the amount of inventory held in the channel. For our pet health business, demand in our direct to retailer and e-commerce channels could be negatively impacted by economic conditions as they fluctuate.

In our farm animal business, demand has been negatively impacted by processing plant closures, resulting in a backlog of animals ready for processing, and weakened food service demand, which collectively have pressured producer economics. Processing plants have adjusted operations and have cleared most of the backlog, and demand for certain protein categories continues to recover. While the impact has been most significant for the U.S. livestock industry, particularly in the second and third quarters of 2020, the pressure has occurred globally and across species. As the pandemic has continued through the beginning of 2021, our business has been affected by lower levels of demand in certain markets due to unfavorable macroeconomic conditions and reduced food service consumption. As a result, the industry has seen pressured prices and producer profitability across species, most notably in international poultry and aqua. We anticipate that recovery of end consumer demand, particularly in the food service business as compared to prior year will continue to occur, particularly impacting our farm animal business, throughout 2021.

Our third party distributors may face difficulties maintaining operations and normal liquidity in light of government-mandated restrictions. Due to liquidity and working capital pressure caused by the COVID-19 pandemic, our distributors continue to manage inventory more tightly. In response to this along with a shift in tactics for demand generation with our distributors, we reduced channel inventory levels during the first half of 2020 as we tightened our approach across all facets of our distributor relationships. We estimate that this decreased our revenue by
2021 Q1 Form 10-Q | 30
elan-20210331_g1.jpg

approximately $160 million. These actions have allowed us to improve working capital management, increase gross margin, implement new compensation structures with our distributors and enable greater control of overall stock levels. We continue to monitor the impacts on our customers' liquidity and therefore our ability to collect on our accounts receivable. While our allowance on these receivables factors in expected credit losses, disruption and declines in the global economy could result in difficulties in our ability to collect, which we have not experienced on a material basis at this time. If significant issues with collections occur, material increases in our allowance for doubtful accounts may be required.

Our Acquisition of Bayer Animal Health and KindredBio

We have incurred and expect to continue to incur expenses in connection with our acquisitionacquisitions of Bayer Animal Health and KindredBio, including fees for professional services such as legal, accounting, consulting, and other advisory fees and expenses. Expenses incurred in 2021 and thus far in 2022 are primarily relaterelated to integration activities. In addition, we have incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics and to expand administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by the former parent company of Bayer Animal Health. We anticipate that these additional costs will be partially offset by expected synergies.

Product Development and New Product Launches

A key element of our targeted value creation strategy is to drive growth through portfolio development and product innovation. We continue to pursue the development of new chemical and biological molecules through our approach to innovation. Our future growth and success depend on both our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition, and the expansion of the use of our existing products. We believe we are an industry leader in animal health R&D, with a track record of product innovation, business development and commercialization.

Competition

We face intense competition. Principal methods of competition vary depending on the particular region, species, product category, or individual product. Some of these methods include new product development, including generic alternatives to our products, quality, price, service and promotion.

Our primary competitors include animal health medicines and vaccines companies such as Zoetis Inc.; Boehringer Ingelheim Vetmedica, Inc., the animal health division of Boehringer Ingelheim GmbH; and Merck Animal Health, the animal health division of Merck & Co., Inc. We also face competition globally from manufacturers of generic drugs, as well as from producers of nutritional health products, such as DSM Nutritional Products AG and Danisco Animal Nutrition, the animal health division of E.I. du Pont de Nemours and Company, a subsidiary of DowDuPont, Inc. There are also several new start-up companies working in the animal health area. In addition, we compete with numerous other producers of animal health products throughout the world.

Productivity

Our results during the periods presented have benefited from operational and productivity initiatives implemented following recent acquisitions and in response to changing market demand for antibiotics and other headwinds.

2022 Q1 Form 10-Q | 29
elan-20220331_g1.jpg
Table of Contents
Prior to the acquisition of Bayer Animal Health, our acquisitions within the last six years added in the aggregate $1.4 billion in revenue, 4,600 full-time employees, and 12 manufacturing and eight R&D sites. The acquisitionacquisitions of Bayer Animal Health on August 1, 2020 and KindredBio on August 27, 2021 added 3,9003,950 full-time employees, eight10 manufacturing sites, and fourfive R&D sites.sites (before company-wide restructuring activities initiated in 2020 and 2021). In addition, from 2015 to 2020,2021, changing market demand for antibiotics and other headwinds, such as competition with generics and innovation, affected some of our highest gross margin products, resulting in a change to our product mix and driving operating margin lower. In response, we implemented a number of initiatives across the manufacturing, R&D and marketing, selling general and administrative (SG&A) functions. Our manufacturing cost savings strategies included improving manufacturing processes and headcount through lean manufacturing (minimizing waste while maintaining productivity), closing and selling manufacturing sites, consolidating our CMO network, strategically insourcing certain projects, and pursuing cost savings opportunities with respect to raw materials via a new procurement process.through alternate sources of supply. Additional cost savings have resulted from reducing the number of R&D sites, SG&A savings
2021 Q1 Form 10-Q | 31
elan-20210331_g1.jpg

from sales force consolidation and reducing discretionary and other general and administrative (G&A) operating expense.expenses.

Seasonality

The results of our pet health business may fluctuate due to seasonality. For example, based upon historical results, approximately 70% and 60% of total annual revenue contributed by our higher-margin parasiticide products Seresto and Advantage Family, respectively, has occurred during the first half of the year, which is reflective of the flea and tick season in the Northern Hemisphere. Therefore, a period-to-period comparison of our historical results may not be meaningful and fluctuations in total revenue for our pet health products are not necessarily an indication of future performance.

Foreign Exchange Rates

Significant portions of our revenue and costs are exposed to changes in foreign exchange rates. Our products are sold in more than 90 countries and, as a result, our revenue is influenced by changes in foreign exchange rates. During the three months ended March 31, 20212022 and 2020,2021, approximately 54% and 49%, respectively, of our revenue was denominated in foreign currencies. As we operate in multiple foreign currencies, including the Euro, British pound, Swiss franc, Brazilian real, Australian dollar, Japanese yen, Canadian dollar, Chinese yuan, and other currencies, changes in those currencies relative to the U.S. dollar impact our revenue, cost of sales and expenses, and consequently, net income. These fluctuations may also affect the ability to buy and sell our products between markets impacted by significant exchange rate variances. Currency movements decreased revenue by 3% during the three months ended March 31, 2022. Currency movements had a limited impact on revenue during the three months ended March 31, 2021 and 2020.2021.

Our Relationship with Lilly and Additional Standalone Costs

All operations-focused TSAs that went into effect after our 2018 separation from Lilly were exited as planned on March 31, 2021. We are nearly complete with investments in expanding our own administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by Lilly. Because of initial stand up costs and overlaps with services previously provided by Lilly, we have incurred and expect to continue to incur certain temporary, duplicative expenses in connection with the Separation. We have also incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics, among others. We currently estimate these costs taken together to be in a range from $315 million to $335 million, net of completed and planned real estate dispositions and employee benefit changes, of which a portion will be capitalized and the remainder will be expensed.

Asset Impairment, Restructuring and Other Special Charges

During the three months ended March 31, 2021 and 2020 including in connection with the productivity initiatives described above under "Factors Affecting Our Results of Operations - Productivity," we incurred charges related to asset impairment, restructuring and other special charges, including integration of acquired businesses. These charges include severance costs resulting from actions taken to reduce our costs, asset impairment charges primarily related to competitive pressures for certain pet health products, product rationalizations, site closures and integration costs related to acquired businesses, primarily Bayer Animal Health, and costs related to the build out of processes and systems to support finance and global supply and logistics, among others, as we stand our organization up as an independent company.

For more information on these charges, see Note 5: Asset Impairment, Restructuring and Other Special Charges to the condensed consolidated financial statements.
2022 Q1 Form 10-Q | 30
elan-20220331_g1.jpg

Table of Contents
Results of Operations

The following discussion and analysis of our results of operations should be read along with our condensed consolidated financial statements and the notes thereto.
2021 Q1 Form 10-Q | 32
elan-20210331_g1.jpg

Three Months Ended March 31,Three Months Ended March 31,
(Dollars in millions)(Dollars in millions)20212020% Change(Dollars in millions)20222021% Change
RevenueRevenue$1,242 $658 89 %Revenue$1,225 $1,242 (1)%
Costs, expenses and other:Costs, expenses and other:Costs, expenses and other:
Cost of salesCost of sales569 333 71 %Cost of sales509 569 (11)%
% of revenue% of revenue46 %51 %(5)%% of revenue42 %46 %(4)%
Research and developmentResearch and development89 67 33 %Research and development81 89 (9)%
% of revenue% of revenue7 %10 %(2)%% of revenue7 %7 %— %
Marketing, selling and administrativeMarketing, selling and administrative348 182 91 %Marketing, selling and administrative320 348 (8)%
% of revenue% of revenue28 %28 %— %% of revenue26 %28 %(2)%
Amortization of intangible assetsAmortization of intangible assets147 52 183 %Amortization of intangible assets137 147 (7)%
% of revenue% of revenue12 %8 %4 %% of revenue11 %12 %(1)%
Asset impairment, restructuring and other special chargesAsset impairment, restructuring and other special charges108 75 44 %Asset impairment, restructuring and other special charges46 108 (57)%
Interest expense, net of capitalized interestInterest expense, net of capitalized interest61 16 281 %Interest expense, net of capitalized interest52 61 (15)%
Other expense, netOther expense, net— 1 NMOther expense, net9 — NM
Loss before income taxes(80)(68)18 %
Income (loss) before income taxesIncome (loss) before income taxes71 (80)189 %
% of revenue% of revenue(6)%(10)%4 %% of revenue6 %(6)%12 %
Income tax benefit(19)(19)— %
Net loss$(61)$(49)24 %
Income tax expense (benefit)Income tax expense (benefit)23 (19)221 %
Net income (loss)Net income (loss)$48 $(61)179 %
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful

Disaggregated Revenue

On a global basis, our revenue by product category for the three months ended March 31 is summarized as follows:
Revenue% of Total RevenueIncrease (Decrease)Revenue% of Total RevenueIncrease (Decrease)
(Dollars in millions)(Dollars in millions)2021202020212020$ Change% Change
CER (1)
(Dollars in millions)2022202120222021$ Change% Change
CER (1)
Pet HealthPet Health$645 $206 52 %31 %$439213 %211 %Pet Health$639 $645 52 %52 %$(6)(1)%2 %
Farm AnimalFarm Animal578 433 47 %66 %14533 %34 %Farm Animal569 578 46 %47 %(9)(2)%1 %
SubtotalSubtotal1,223 639 98 %97 %58491 %91 %Subtotal1,208 1,223 99 %98 %(15)(1)%2 %
Contract Manufacturing(2)
Contract Manufacturing(2)
19 19 2 %3 %—— %— %
Contract Manufacturing(2)
17 19 1 %2 %(2)(11)%(8)%
TotalTotal$1,242 $658 100 %100 %58489 %88 %Total$1,225 $1,242 100 %100 %(17)(1)%2 %
Note: Numbers may not add due to rounding
(1)Constant exchange rate (CER), a non-GAAP measure, is defined as revenue growth excluding the impact of foreign exchange. The calculation assumes the same foreign currency exchange rates that were in effect for the comparable prior-year period were used in translation of the current period results. We believe this metric provides a useful comparison to previous periods.
(2)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.

Total revenue increased $584 million to $1,242 million comprised
2022 Q1 Form 10-Q | 31
elan-20220331_g1.jpg
Table of $683 million fromContents
On a global basis, the legacy Elanco portfolio and $559 million from the legacy Bayer Animal Health portfolio. This 89% increase reflects a 86% increase in volume, a 2% increase ineffect of price, and a limited favorable impact from foreign exchange rates.

The detailed changerates and volumes on changes in revenue by product categoryfor the three months ended March 31, 2022 and 2021 was as follows:

First quarter of 2022
(Dollars in millions)

Revenue		PriceFX RateVolumeTotalCER
Pet Health$639 2%(3)%—%(1)%2%
Farm Animal569 1%(3)%—%(2)%1%
Subtotal1,208 2%(3)%—%(1)%2%
Contract Manufacturing17 —%(3)%(8)%(11)%(8)%
Total$1,225 2%(3)%—%(1)%2%
•
First quarter of 2021
(Dollars in millions)

Revenue		PriceFX Rate
Volume (1)
TotalCER
Pet Health$645 2%2%210%213%211%
Farm Animal578 2%—%31%33%34%
Subtotal1,223 2%—%89%91%91%
Contract Manufacturing19 —%—%—%—%—%
Total$1,242 2%—%86%89%88%
Note: Numbers may not add due to rounding
(1)Impact of 2021 revenue from Bayer Animal Health is reflected in volume.

Revenue

Pet Health revenue increaseddecreased by $439$6 million, or 213%less than 1%, for the quarter, driven by an unfavorable impact from foreign exchange rates, partially offset by an increase in price. On a constant currency basis, an increase in international pet health revenue was partially offset by a decline in U.S. pet health revenue. In addition, growth in newer generation parasiticides and pain products was partially offset by declines in older generation parasiticides.

Farm Animal revenue decreased by $9 million, or 2%, for the quarter, driven by an unfavorable impact from foreign exchange rates, partially offset by an increase in price. Improved producer demand and innovation in poultry as well as strong aqua demand was partially offset by a decline in demand in the swine market, particularly in China, as compared to the first quarter of 2021. Additionally, cattle declined in the quarter primarily driven by generic competition impacting price on several key brands.

Cost of Sales
Three Months Ended March 31,
(Dollars in millions)20222021% Change
Cost of sales$509 $569 (11)%
% of revenue42 %46 %

Costs of sales as a resultpercentage of revenue decreased for three months ended March 31, 2022, primarily due to amortization of the additionfair value adjustment of $62 million recorded from the acquisition of Bayer Animal Health product revenue of $369 million in the quarter. The increasefirst quarter of 2021 and improvements in manufacturing productivity, partially offset by unfavorable inflationary impacts on input costs, freight and conversion costs. Excluding the legacy Elanco business was driven by$62 million fair value adjustment for the three months ended March 31, 2021, cost of sales as a favorable comparison to the prior year, during which we reduced channel inventory levels with our distributors, negatively impactingpercentage of revenue bywould have been approximately $60 million. Growth in the legacy Elanco business was also attributable to higher volume in newer generation parasiticide and pain products.41%.

20212022 Q1 Form 10-Q | 3332
elan-20220331_g1.jpg

Table of Contents
•Farm Animal revenue increased by $145 million, or 33%, for the quarter, driven by an increase in revenue as a result of the addition of Bayer Animal Health product revenue of $174 million in the quarter. Legacy Elanco revenue declined as a result of an unfavorable comparison to the prior year, which included anticipatory buying by direct customers in international export markets to ensure continuity of supply ahead of potential COVID-19 disruptions. In addition, the decline in the current period was driven by lower levels of demand in certain markets due to the negative impact of the COVID-19 pandemic on poultry and aqua consumption, production, and profitability as well as generic competition, partly offset by increased demand in China and price growth.
•Contract Manufacturing revenue remained flat at $19 million, and represented 2% of total revenue. Contract manufacturing revenue for the period includes $16 million resulting from the acquisition of Bayer Animal Health.
Cost of Sales
Three Months Ended March 31,
(Dollars in millions)20212020% Change
Cost of sales$569 $333 71 %
% of revenue46 %51 %

Cost of sales increased 71%, primarily due to the amortization of the fair value adjustment to inventory of $62 million due to the acquisition of Bayer Animal Health along with an increase in legacy Elanco sales. Excluding the amortization of the inventory fair value adjustment, cost of sales would have been approximately 41% of revenue, compared to 51% in the prior year. This decrease is due to the inclusion of Bayer Animal Health products, which have higher margins, along with continued improvements in manufacturing productivity and increases in price.

Research and developmentDevelopment
Three Months Ended March 31,Three Months Ended March 31,
(Dollars in millions)(Dollars in millions)20212020% Change(Dollars in millions)20222021% Change
Research and developmentResearch and development$89 $67 33 %Research and development$81 $89 (9)%
% of revenue% of revenue7 %10 %% of revenue7 %7 %

R&D expenses increased 33%, primarily due todecreased $8 million for the inclusionthree months ended March 31, 2022. R&D expenses were favorably impacted by cost savings realized as a result of the Bayer Animal Health business. As a percent of revenue, research and development was 7% compared to 10% in the prior year, partly due to a delay of some project spend from the first quarter to the second quarter.2021 restructuring activities.

Marketing, sellingSelling and administrativAdministrative
Three Months Ended March 31,Three Months Ended March 31,
(Dollars in millions)(Dollars in millions)20212020% Change(Dollars in millions)20222021% Change
Marketing, selling and administrativeMarketing, selling and administrative$348 $182 91 %Marketing, selling and administrative$320 $348 (8)%
% of revenue% of revenue28 %28 %% of revenue26 %28 %

Marketing, selling and administrative expenses decreased $28 million for the three months ended March 31, 2022, primarily driven by disciplined cost management across the business and cost savings realized as a percentageresult of revenue were flat year over year. Expenses as a percentage2021 restructuring activities.

Amortization of revenue remained flatIntangible Assets
Three Months Ended March 31,
(Dollars in millions)20222021% Change
Amortization of intangible assets$137 $147 (7)%

Amortization of intangible assets decreased $10 million for the three months ended March 31, 2022, primarily due to the timing of finalizing the valuation of intangible assets acquired from the Bayer Animal Health acquisition and the impact of foreign exchange rates.

Asset Impairment, Restructuring and Other Special Charges
Three Months Ended March 31,
(Dollars in millions)20222021% Change
Asset impairment, restructuring and other special charges$46 $108 (57)%

For additional information regarding our asset impairment, restructuring and other special charges, see Note 6: Asset Impairment, Restructuring and Other Special Charges to the condensed consolidated financial statements.

Asset impairment, restructuring and other special charges decreased $62 million for the three months ended March 31, 2022, primarily due to a delayperiod over period decrease in overall acquisition-related charges, which include transaction costs related to acquisitions and costs associated with the implementation of planned spend for direct-to-consumernew systems, programs, and digital advertisingprocesses due to both our separation from Lilly and the integration of Bayer Animal Health. The decrease was also driven by lower severance charges as compared to 2021. These decreases were partially offset by a $28 million asset write-down charge recorded upon the final sale of our Speke site during the first quarter toof 2022.

Interest Expense, Net of Capitalized Interest
Three Months Ended March 31,
(Dollars in millions)20222021% Change
Interest expense, net of capitalized interest$52 $61 (15)%

Interest expense, net of capitalized interest decreased for the second quarter resulting from a cooler early parasiticide season. Expenses increased 91% over prior year,three months ended March 31, 2022, primarily due to the acquisitionfavorable impact of Bayer Animal Health and increased information technology spending.refinancing at lower interest rates.
20212022 Q1 Form 10-Q | 3433
elan-20220331_g1.jpg

Table of Contents

Amortization of intangible assetsOther Expense, Net
Three Months Ended March 31,Three Months Ended March 31,
(Dollars in millions)(Dollars in millions)20212020% Change(Dollars in millions)20222021% Change
Amortization of intangible assets$147 $52183 %
Other expense, netOther expense, net$9 $— NM

Amortization of intangible assets increased $95 million, primarily due to the addition of amortization of intangible assetsOther expense recorded from the acquisition of Bayer Animal Health.

Asset impairment, restructuring and other special charges
Three Months Ended March 31,
(Dollars in millions)20212020% Change
Asset impairment, restructuring and other special charges$108 $7544 %


Asset impairment, restructuring and other special charges increased $33 million, primarily due to severance associated with the restructuring program announced during the first quarterthree months ended March 31, 2022 primarily consisted of 2021, an asset impairment charge recorded to adjust the fair value of intangible assets that were subject to product rationalization, higher integration costs of acquisitions,mark-to-market adjustments on equity investments and costs associated with the implementation of new systems, programs, and processes due to our separation from Lilly and in connection with the acquisition of Bayer Animal Health, as more fully described in Note 5. These increases wereforeign exchange losses, partially offset by adjustments to severance accruals under the September 2020 program primarily as a resultcertain components of restructured personnel filling open positions and favorable negotiations, and a related pension curtailment gain from the September 2020 and January 2021 programs.

For additional information regarding our asset impairment, restructuring and other special charges, seenet periodic benefit cost. See Note 5: Asset Impairment, Restructuring and Other Special Charges14: Retirement Benefits to the condensed consolidated financial statements.

Interest expense,statements for further discussion related to net of capitalized interest
Three Months Ended March 31,
(Dollars in millions)20212020% Change
Interest expense, net of capitalized interest$61 $16281 %

Interest expense, net of capitalized interest, increased $45 million, primarily due to interest associated withperiodic benefit cost (income) recorded during the term loan B entered into August 1, 2020 and used to finance the Bayer Animal Health acquisition.

Other expense, net
Three Months Ended March 31,
(Dollars in millions)20212020% Change
Other expense, net$— $1NM

period. Other expense recorded during the three months ended March 31, 2021 consisted of losses recorded in relation to divestitures. This was fully offset by up-front payments received, milestones earned, and equity issued to us in relation to a license agreement. Other expense recorded during the three months ended March 31, 2020 was primarily composed of foreign exchange losses.

Income tax benefitTax Expense (Benefit)
Three Months Ended March 31,Three Months Ended March 31,
(Dollars in millions)(Dollars in millions)20212020% Change(Dollars in millions)20222021% Change
Income tax benefit$(19)$(19)— %
Income tax expense (benefit)Income tax expense (benefit)$23 $(19)(221)%
Effective tax rateEffective tax rate23.5 %27.6 %Effective tax rate32.1 %23.5 %

Income tax benefit was $19 millionexpense increased for the three months ended March 31, 2021 and 2020.2022, primarily due to positive pre-tax earnings. The effective tax rates
2021 Q1 Form 10-Q | 35
elan-20210331_g1.jpg

rate increased for both periods were impactedthe three months ended March 31, 2022 and differs from the statutory income tax rate largely due to certain research and experimentation costs being capitalized beginning January 1st, 2022, as provided under the Tax Cuts and Jobs Act. This has increased the expected profits in jurisdictions with higher statutory tax rates as well as expected U.S. international tax inclusions, which are partially offset by utilization of net discrete tax items.operating losses and valuation allowance release in the U.S. See Note 10:11: Income Taxes to the condensed consolidated financial statements for further discussion.statements.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities.credit facilities. As a significant portion of our business is conducted internationally, we hold a significant portion of cash outside of the U.S. We monitor and adjust the amount of foreign cash based on projected cash flow requirements. Our ability to use foreign cash to fund cash flow requirements in the U.S. may be impacted by local regulations and, to a lesser extent, following U.S. tax reforms, the income taxes associated with transferring cash to the U.S. We currently intend to indefinitely reinvest foreign earnings for continued use in our foreign operations. As our structure evolves as a standalone company, we may change that strategy, particularly to the extent we identify tax efficient reinvestment alternatives for our foreign earnings or change our cash management strategy.

We believe our primary sources of liquidity are sufficient to fund our short-term and long-term existing and planned capital requirements, which include working capital obligations, funding existing marketed and pipeline products, capital expenditures, business development in our targeted areas, short-term and long-term debt obligations which include principal and interest payments as well as interest rate swaps, operating lease payments, purchase obligations, and costs associated with the integrationintegrations of Bayer Animal Health.Health and KindredBio. In addition, we have the ability to access capital markets to obtain debt refinancing for longer-term funding, if required, to service our long-term debt obligations. Further, we believe we have sufficient cash flow and liquidity to remain in compliance with our debt covenants.

Our ability to meet future funding requirements may be impacted by macroeconomic, business and financial volatility. As markets change, we will continue to monitor our liquidity position. However, a challenging economic environment or an economic downturn may impact our liquidity or ability to obtain future financing. See "Item 1A. Risk Factors - We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful" in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020.2021.

2022 Q1 Form 10-Q | 34
elan-20220331_g1.jpg
Table of Contents
Cash Flows

The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented:

(Dollars in millions)(Dollars in millions)Three Months Ended March 31,(Dollars in millions)Three Months Ended March 31,
Net cash provided by (used for):Net cash provided by (used for):20212020$ ChangeNet cash provided by (used for):20222021$ Change
Operating activitiesOperating activities$22 $4 $18 Operating activities$(62)$22 $(84)
Investing activitiesInvesting activities10 (20)30 Investing activities(29)10 (39)
Financing activitiesFinancing activities2 897 (895)Financing activities(200)2 (202)
Effect of exchange-rate changes on cash and cash equivalentsEffect of exchange-rate changes on cash and cash equivalents(25)(9)(16)Effect of exchange-rate changes on cash and cash equivalents(5)(25)20 
Net increase in cash, cash equivalents and restricted cash$9 $872 $(863)
Net increase (decrease) in cash and cash equivalentsNet increase (decrease) in cash and cash equivalents$(296)$9 $(305)

Operating activities

OurOperating cash flows decreased $84 million, to a use of $62 million for the three months ended March 31, 2022 as compared to cash provided by operating activities increased by $18 million, toof $22 million for the three months ended March 31, 2021 from $4 million for2021. Cash used in operating activities during the period was negatively impacted by changes in operating assets and liabilities, particularly changes in accounts receivable, accounts payable and other liabilities as compared to the three months ended March 31, 2020. The2021, partially offset by an increase was driven by higherin net income after excluding amounts related to non-cash operating activities, including depreciation and amortization and inventory fair value step-up amortization. This increase was partially offset by the impact of changes in operating assets and liabilities. The COVID-19 global health pandemic and related economic downturn led to an increase in customer accounts receivable that were past due at the end of the first quarter of 2020; however, customer collections improved throughout the remainder of the year and payment terms decreased.activities. In the past, we have extended our payment terms for distributors on occasion. Although we presently have no plans to do so in the future, it is possible that we will need to extend payment terms in certain situations as a result of the COVID-19 global health pandemic, competitive pressures and the need for certain inventory levels at our channel distributors to avoid supply disruptions. If so, such extensions of customer payment terms could result in additional uses of our cash flow.

2021 Q1 Form 10-Q | 36
elan-20210331_g1.jpg

Investing activities

Our cash used for investing activities was $29 million for three months ended March 31, 2022 as compared to cash provided by investing activities wasof $10 million for the three months ended March 31, 2021 as compared to2021. The change was primarily driven by cash used for investing activities of $20 millionreceived for the three months ended March 31, 2020. The change was primarily driven by a decrease in the cash consideration paid to acquire Bayer Animal Health2021 due to the finalization of the working capital adjustment duringfor the period,acquisition of Bayer Animal Health, partially offset by purchasesthe purchase of intangible assets.assets during that same period.

Financing activities

Our cash used for financing activities was $200 million for three months ended March 31, 2022 as compared to cash provided by financing activities decreased by $895 million toof $2 million for the three months ended March 31, 2021 from $897 million for2021. Cash used in financing activities during the three months ended March 31, 2020.2022 reflected the repayment of indebtedness outstanding under our Term Loan B credit facility and net repayments on our revolving credit facility. Cash provided by financing activities during the three months ended March 31, 2021 reflected net proceeds from our revolving credit facility, partially offset by the repayment of indebtedness outstanding under our term loanTerm Loan B credit facility. Cash provided by financing activities during the three months ended March 31, 2020, reflected proceeds from issuances of common stock and TEUs during the period, partially offset by the repayment of indebtedness outstanding under our previous term loan facility.

Description of Indebtedness

For a complete description of our description of our debt and available credit facilities as of March 31, 20212022 and December 31, 2020,2021, see Note 8:9: Debt to the condensed consolidated financial statements.

Off Balance-Sheet Arrangements

Other than the commitments and contingencies disclosed in Note 11: Commitments and Contingencies, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations, or liquidity.

Contractual Obligations

Our contractual obligations and commitments as of March 31, 20212022 are primarily comprised of long-term debt obligations, including interest payments,operating leases, and purchase obligations. Our long-term debt obligations are comprised of our expected principal and interest obligations and our interest rate swaps. Purchase obligations consist of open purchase orders as of March 31, 20212022 and contractual payment obligations with significant vendors which are noncancelable and are not contingent. These obligations are primarily short-term in nature.

Critical Accounting Policies
2022 Q1 Form 10-Q | 35
elan-20220331_g1.jpg
Table of Contents
As of March 31, 2022, we also have an additional lease commitment that has not yet commenced for our new corporate headquarters in Indianapolis, Indiana. Total minimum lease payments are estimated to be approximately $310 million over a term of 25 years, excluding extensions. Final lease payments may vary depending on the actual cost of certain construction activities. Lease commencement is expected in 2024.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Certain of our accounting policies are considered critical because these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments by us, often requiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from our estimates could have an unfavorable effect on our financial position and results of operations. We apply estimation methodologies consistently from year to year. Such policies are summarized in Item 7, "Management's Discussion & Analysis of Results of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended December 31, 2020.2021. There have been no significant changes in the application of our critical accounting policies during the three months ended March 31, 2021.2022.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Exchange Risk

We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange rates. We are primarily exposed to foreign exchange risk with respect to net assets denominated in the Euro, British pound, Swiss franc, Brazilian real, Australian dollar,
2021 Q1 Form 10-Q | 37
elan-20210331_g1.jpg

Japanese yen, Canadian dollar, and Chinese yuan.

We face foreign currency exchange exposures when we enter into transactions arising from subsidiary trade and loan payables and receivables denominated in foreign currencies and purchases of local subsidiaries due to local regulations as a result of the acquisition of Bayer Animal Health.currencies. We also face currency exposure that arises from translating the results of our global operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of the period. We may enter into foreign currency forward or option derivative contracts to reduce the effect of fluctuating currency exchange rates in future periods.

We estimate that a hypothetical 10% adverse movement in all foreign currency exchange rates related to the translation of the results of our foreign operations would decrease our net income by approximately $6 million for the three months ended March 31, 2021.2022.

We generally identify hyperinflationary markets as those markets whose cumulative inflation rate over a three-year period exceeds 100%. We have concluded that our Argentina subsidiary is operating in a hyperinflationary market. As a result, beginning in the second quarter of 2018, the functional currency of our Argentina subsidiary changed from the local currency to the U.S. dollar. During the three months ended March 31, 2022, revenue in Argentina represented less than 1% of our consolidated revenue. Assets held in Argentina as of March 31, 2022 represented less than 1% of our consolidated assets.

During the first quarter of 2022, Turkey’s three-year cumulative inflation rate exceeded 100%, and we concluded that Turkey became a hyperinflationary economy for accounting purposes. As of April 1, 2022, we expect to apply hyperinflationary accounting for our subsidiary in Turkey and change its functional currency from the Turkish lira to the U.S. dollar. During the three months ended March 31, 2022, revenue in Turkey represented less than 1% of our consolidated revenue. Assets held in Turkey as of March 31, 2022 represented less than 1% of our consolidated assets.

While the hyperinflationary conditions did not have a material impact on our business during the three months ended March 31, 2022, in the future, we may incur larger currency devaluations, which could have a material adverse impact on our results of operations.

2022 Q1 Form 10-Q | 36
elan-20220331_g1.jpg
Table of Contents
Interest Risk

Borrowings under our term loan B credit facility areOur variable-rate debt is exposed to interest rate fluctuations based on LIBOR. As of March 31, 2021,2022, we held certain interest rate swap agreements with a notional value of approximately $4.1 billion$3,550 million that have the economic effect of modifying theour variable-interest obligations associated with the term loan B credit facility, so that a portion of the variable-rate interest payable becomes fixed. During the three months ended March 31, 2021,2022, we recorded a gain of $53$109 million, net of taxes on these interest rate swaps in other comprehensive loss. The gain is primarily attributable to an increase in the U.S. Treasury yield curve during the first quarter of 2021.income (loss). See Note 9:10: Financial Instruments and Fair Value to the condensed consolidated financial statements for further information.

Recently Issued Accounting Pronouncements

For discussion of our new accounting standards, see Note 2: Implementation of New Financial Accounting Pronouncements to the condensed consolidated financial statements.

ITEM 4. CONTROLS AND PROCEDURES

(a)Evaluation of Disclosure Controls and Procedures. Under applicable SEC regulations, management of a reporting company, with the participation of the principal executive officer and principal financial officer, must periodically evaluate the company’s “disclosure controls and procedures,” which are defined generally as controls and other procedures of a reporting company designed to ensure that information required to be disclosed by the reporting company in its periodic reports filed with the SEC (such as this Form 10-Q) is recorded, processed, summarized, and reported on a timely basis.

Our management, with the participation of Jeffrey N. Simmons, president and chief executive officer, and Todd S. Young, executive vice president and chief financial officer, evaluated our disclosure controls and procedures as of March 31, 2021.2022. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the disclosure controls and procedures are effective.

(b)Changes in Internal Controls. AsDuring the first quarter of March 31, 2021, management is in the process of integrating the internal controls of the acquired Bayer Animal Health business into our existing operations as part of planned integration activities. In addition, we have transitioned from a Lilly solutions center to a newly established Elanco solutions center and substantially completed the implementation of our new Enterprise Resource Planning (ERP) system during the three months ended March 31, 2021. Other than the controls enhanced or implemented to integrate the Bayer Animal Health business and certain control processes that2022, there were updated to reflect our ERP implementation, there has been no changechanges in our internal control over financial reporting during the quarter ended March 31, 2021, that has materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting. As additional transformation activities occur, we will continue to monitor

PART II

ITEM 1. LEGAL PROCEEDINGS

See Note 12: Commitments and evaluate our internal control over financial reporting. Further, we have not experienced any material impact to our internal controls over financial reporting despite our accounting, finance, and legal employees working remotely dueContingencies to the COVID-19 pandemic. Wecondensed consolidated financial statements for a summary of our legal proceedings, which is incorporated herein by reference.

ITEM 1A. RISK FACTORS

Our risk factors are continually monitoring and assessing COVID-19 ondocumented in Item 1A of Part I of our internal controls to minimizeForm 10-K for the impact on their design and operating effectiveness.year ended December 31, 2021, which is incorporated herein by reference. There have been no material changes from the risk factors previously disclosed in the Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(none)

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

(none)

20212022 Q1 Form 10-Q | 3837
elan-20220331_g1.jpg

Table of Contents
PART II
ITEM 1. LEGAL PROCEEDINGS

4. MINE SAFETY DISCLOSURES
See Note 11: Commitments and Contingencies to the condensed consolidated financial statements for a summary of our legal proceedings.

ITEM 1A. RISK FACTORS

Other than the revisions set forth below, there have been no material changes from the risk factors disclosed in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020.

The following risk factor has been changed from the risk factor that was previously disclosed:

Unanticipated safety, quality or efficacy concerns or identified concerns associated with our products may harm our reputation and have an adverse impact on our performance.

Unanticipated safety, quality or efficacy concerns arise from time to time with respect to animal health products, whether or not scientifically or clinically supported, potentially leading to product recalls, withdrawals or suspended or declining sales, as well as product liability and other claims. Regulatory actions based on these types of safety, quality or efficacy concerns could impact all, or a significant portion, of a product’s sales.

For example, lawsuits seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been filed against us arising out of the use of Seresto, a non-prescription flea and tick collar for cats and dogs, based on reports alleging that the collar has caused injury and death to pets. Further, a U.S. House of Representative subcommittee chair requested that we produce certain documents and information related to the Seresto collar and further made a request to temporarily remove Seresto collars from the market. Similar actions relating to Seresto could be taken by regulatory agencies. If any such claims with respect to Seresto or our other products are resolved adversely to us, or if a regulatory agency determines that a recall of any of our products, including Seresto, is necessary, such action could cause harm to our reputation, reduce our product sales, result in monetary penalties and other costly remedies against us, and could therefore have a material adverse effect on our business, financial condition and results of operations.

In addition, we depend on positive perceptions of the safety, quality and efficacy of our products, and animal health products in general, by food producers, veterinarians and pet owners. Any concern as to the safety, quality or efficacy of our products, whether actual or perceived, may harm our reputation. These concerns, including those relating to Seresto, and the related harm to our reputation could materially adversely affect our business, financial condition and results of operations, regardless of whether such reports are accurate.

2021 Q1 Form 10-Q | 39
elan-20210331_g1.jpg

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(none)

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

(none)

ITEM 4. MINE SAFETY DISCLOSURES

(none)

ITEM 5. OTHER INFORMATION

(none)
20212022 Q1 Form 10-Q | 4038
elan-20220331_g1.jpg

Table of Contents
ITEM 6. EXHIBITS

The following exhibits are either filed or furnished herewith (as applicable) or, if so indicated, incorporated by reference to the documents indicated in parentheses, which have previously been filed or furnished with the Securities and Exchange Commission.

Exhibit NumberDescription
10.1 
10.2 
10.3 
10.1 
31.1 
31.2 
32 
101 Interactive Data Files
104 Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101)

20212022 Q1 Form 10-Q | 4139
elan-20220331_g1.jpg

Table of Contents
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
ELANCO ANIMAL HEALTH INCORPORATED
(Registrant)
Date:May 7, 20219, 2022/s/ Jeffrey N. Simmons
Jeffrey N. Simmons
President and Chief Executive Officer
Date:May 7, 20219, 2022/s/ Todd S. Young
Todd S. Young
Executive Vice President, Chief Financial Officer

20212022 Q1 Form 10-Q | 4240
elan-20220331_g1.jpg